Mercer-Capital_Bank-Watch_2022-7.pdf

www.mercercapital.com
Second Quarter 2018
JULY 2022
Bank Watch
Strategic Benefits of Stress Testing in an Uncertain
Economic Environment
BUSINESS VALUATION &
FINANCIAL ADVISORY SERVICES
In This Issue
ARTICLE
Strategic Benefits of Stress Testing
in an Uncertain Economic
Environment1
Public Market Indicators 6
MA Market Indicators 7
Regional Public
Bank Peer Reports 8
About Mercer Capital 9

© 2022 Mercer Capital // www.mercercapital.com 1
Mercer Capital’s Bank Watch July 2022
Strategic Benefits of Stress Testing in an Uncertain Economic Environment
Having gone on many a camping trip over the years, the only consistency between
these trips into the woods is that there is no consistency.While some trips might have
beautiful weather, others might be plagued with storms, cold fronts, heat waves, or
strong winds. The campsite may or may not have amenities. And most importantly,
contending with the wildlife adds another variable that can’t be predicted. However,
the key element of how the trip goes is how prepared we are. The trips where
we assumed blue skies were by far the most stressful. If we prepared for different
outcomes and weather based on the uncertainty of going into the woods, the trip
could always be salvaged.
Banks and credit unions are currently facing a similar “into the woods” predicament,
as the economic environment seems to grow more volatile and contradictory day
by day. While hiring remains strong and unemployment continues to stay near
historically low levels with the Bureau of Labor Statistics reporting 3.6% as of June
2022, other indicators are flashing warning signs. Inflation concerns continues to
plague the economy after accelerating to 9.1% in June 2022, the highest increase
since November 1981. Drivers of inflation in the past several months include rising
food and gas prices as global supply remains disrupted from Russia’s invasion of
Ukraine and the remnants of the pandemic. Economists are taking notice, with nearly
70% of economists surveyed by the Financial Times and the Initiative on Global
Markets believing that the National Bureau of Economic Research (NBER) will make
a call at some point in 2023 identifying a recession.
These conflicting indicators are convoluting the economic forecast through the
rest of 2022 and 2023, and the differing potential circumstances would have very
different impacts on banks and credit unions. Though this uncertainty can certainly
cause headaches and stress for banks and credit unions worried about their capital
positions in a severely adverse economic scenario, stress testing can help to prepare
your bank or credit union in the face of uncertainty and help to optimize strategic
decisions.
Stress Test Overview
A stress test is defined as a risk management tool that consists of estimating the
bank’s financial position over a time horizon – approximately two years – under
different scenarios (typically a baseline and severely adverse scenario). The OCC’s
supervisory guidance in October 2012 stated “community banks, regardless of size,
should have the capacity to analyze the potential impact of adverse outcomes on
their financial conditions.” 1
Further, the OCC’s guidance considers “some form of
stress testing or sensitivity analysis of loan portfolios on at least an annual basis to
be a key part of sound risk management for community banks.” 2
A stress test can be
defined as “the evaluation of a bank’s financial position under a severe but plausible
scenario to assist in decision making with the bank.” 3
There are a few different types of stress tests that banks and credit unions can utilize
in estimating their financial position:
Transaction Level Stress Testing: This method is a “bottom up” analysis that
looks at key loan relationships individually, assesses the potential impact of adverse
economic conditions on those borrowers, and estimates loan losses for each loan.
Portfolio Level Stress Testing: This method involves the determination of the
potential financial impact on earnings and capital following the identification of key
portfolio concentration issues and assessment of the impact of adverse events or
economic conditions on credit quality. This method can be applied either “bottom
1
OCC 2012-33 “Supervisory Guidance” on Community Bank Stress Testing dated October 18, 2012 and accessed at www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-33.html.
2
Ibid. 3
“Stress Testing for Community Banks” presentation by Robert C. Aaron, Arnold Porter LLP, November 11, 2011.

up,” by assessing the results of individual transaction level stress tests and then
aggregating the results, or “top down,” by estimating stress loss rates under different
adverse scenarios on pools of loans with common characteristics.
Enterprise-Wide Level Stress Testing: This method attempts to take risk
management out of the silo and consider the enterprise-wide impact of a stress
scenario by analyzing “multiple types of risk and their interrelated effects on the
overall financial impact.” 4
The risks might include credit risk, counter-party credit risk,
interest rate risk, and liquidity risk. In its simplest form, enterprise-wide stress testing
can entail aggregating the transaction and/or portfolio level stress testing results
to consider related impacts across the firm from the stressed scenario previously
considered.
By utilizing one or more of these stress testing exercises, banks and credit unions
can better position themselves for multiple different economic scenarios in order to
assure they have sufficient capital and financial strength to withstand an economic
downturn if there is one.
Economic Scenarios Overview
One question that often arises is: Given the uncertainty, what economic scenarios
should we consider in our stress testing? While it is difficult to answer this question,
the most recent Stress Test scenarios prepared by the Federal Reserve are described
in a February 2022 report, 2022 Supervisory Scenarios for Annual Stress Tests
Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,
and provide some guidance to assist with this decision.The scenarios start in the first
quarter of 2022 and extend through the first quarter of 2025. Each scenario includes
28 variables, nineteen of which are related to domestic variables in the U.S.
While the more global economic conditions detailed in the Fed’s supervisory
scenarios may not be applicable to community banks or credit unions, certain
domestic variables within the scenarios could be useful when determining the
economic scenarios to consider.The domestic variables include six measures of real
economic activity and inflation, six measures of interest rates, and four measures
of asset prices. The baseline scenario includes an economic expansion over the
13-quarter scenario period, while the severely adverse scenario is a hypothetical
scenario that includes a severe global recession, accompanied by heightened stress
in commercial real estate and corporate debt markets. Below, we have included
charts of some of the more relevant domestic variables (GDP, unemployment rates,
the Prime Rate, and commercial/residential real estate prices) and their historical
levels through year-end 2021 as well as the Fed’s assumptions for those variables in
the baseline and severely adverse scenarios.
WHAT WE’RE READING
The Federal Reserve increased its benchmark interest rate by 75 basis
points to a range of 2.25% to 2.50%, marking the fourth consecutive policy
meeting resulting in a rate increase.
A recent survey showed that community bank leaders increasingly
expect a recession in 2022 or 2023, with most respondents casting blame
on the Fed.
SP’s U.S. purchasing managers index indicated a steep drop in business
activity in July marking the first contraction in activity since June 2020.
4
OCC 2012-33 “Supervisory Guidance” on Community Bank Stress Testing dated October 18, 2012 and accessed at www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-33.html.

(40.0)
(30.0)
(20.0)
(10.0)
-
10.0
20.0
30.0
40.0
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
2022 Q1
2022 Q3
2023 Q1
2023 Q3
2024 Q1
2024 Q3
2025 Q1
Real
GDP
Growth
(%)
Historical Baseline Severely Adverse
-
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
2022 Q1
2022 Q3
2023 Q1
2023 Q3
2024 Q1
2024 Q3
2025 Q1
Unemployment
Rate
(%)
2022 Supervisory Economic Scenarios Overview

-
1.0
2.0
3.0
4.0
5.0
6.0
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
2022 Q1
2022 Q3
2023 Q1
2023 Q3
2024 Q1
2024 Q3
2025 Q1
Prime
Rate
(%)
-
50.0
100.0
150.0
200.0
250.0
300.0
350.0
400.0
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
2022 Q1
2022 Q3
2023 Q1
2023 Q3
2024 Q1
2024 Q3
2025 Q1
Commercial
Real
Estate
Price
Index
(Level)

Benefits of the Stress Test
As the U.S.moves into a more uncertain economic environment, a financial institution’s
preparation for its trip “into the woods” of this uncertain economic environment can
reap dividends. Improved valuation, performance enhancement from enhanced
strategic decisions, and risk management are some of these benefits. Greater clarity
into the bank or credit union’s capital position, credit risk, and earnings outlook
under different economic circumstances helps management to make more informed
operational decisions.
Conclusion
We acknowledge that bank and credit union stress testing can be a complex exercise.
The bank or credit union must administer the test, determine and analyze the outputs
of its performance, and provide support for key assumptions/results. There is also a
variety of potential stress testing methods and economic scenarios to consider when
setting up their test. In addition, the qualitative, written support for the test and its
results is often as important as the results themselves. For all of these reasons, it is
important that bank and credit union management begin building their stress testing
expertise sooner rather than later.
In order to assist financial institutions with this complex and often time-consuming
exercise, we offer several solutions, including preparing custom stress tests for your
institution or reviewing ones prepared by the institution internally, to make the process
as efficient and valuable as possible.
To discuss your stress testing needs in confidence, please do not hesitate to contact
us. For more information about stress testing, click here.
Mary Jane McCaghren
mccaghrenm@mercercapital.com | 214.2063796

© 2022 Mercer Capital // Data provided by SP Capital IQ Pro. 6
Mercer Capital’s Public Market Indicators July 2022
Mercer Capital’s Bank Group Index Overview Return Stratification of U.S. Banks
by Market Cap
Total Return Regional Index Data as of July 26, 2022
Month-
to-Date Year-to-Date
Last 12
Months
Price/LTM
EPS
Price /
2022 (E)
EPS
Price /
2023 (E)
EPS
Price / Book
Value
Price /
Tangible Book
Value
Dividend
Yield
Atlantic Coast Index 1.4% -10.0% -5.9% 9.4x 9.5x 8.9x 115% 125% 2.7%
Midwest Index -0.7% -4.4% 5.8% 9.2x 9.3x 9.0x 106% 123% 2.9%
Northeast Index 2.0% -2.3% 7.7% 8.9x 9.2x 8.7x 116% 119% 3.0%
Southeast Index 0.6% 4.2% 7.7% 11.4x 9.4x 8.6x 119% 133% 2.4%
West Index 1.2% -11.3% 3.4% 10.0x 8.8x 7.4x 108% 116% 3.0%
Community Bank Index 1.0% -5.8% 3.6% 9.4x 9.3x 8.6x 113% 123% 2.9%
SP U.S. BMI Banks 5.1% -18.4% -10.6% na na na na na na
SP U.S.
Banks Market
Cap Under
$250 Million
SP U.S.
Banks Market
Cap Between
$250 Million -
$1 Billion
SP U.S.
Banks Market
Cap Between
$1 Billion - $5
Billion
SP U.S.
Banks Market
Cap Over $5
Billion
Month-to-Date 1.43% 4.66% 7.30% 4.78%
Year-to-Date -4.53% -8.37% -9.79% -20.00%
Last 12 Months 3.91% 6.91% 3.22% -13.05%
-30%
-20%
-10%
0%
10%
As
of
July
26,
2022
80
90
100
110
120
130
7
/
2
6
/
2
0
2
1
8
/
2
6
/
2
0
2
1
9
/
2
6
/
2
0
2
1
1
0
/
2
6
/
2
0
2
1
1
1
/
2
6
/
2
0
2
1
1
2
/
2
6
/
2
0
2
1
1
/
2
6
/
2
0
2
2
2
/
2
6
/
2
0
2
2
3
/
2
6
/
2
0
2
2
4
/
2
6
/
2
0
2
2
5
/
2
6
/
2
0
2
2
6
/
2
6
/
2
0
2
2
7
/
2
6
/
2
0
2
2
July
26,
2021
=
100
MCM Index - Community Banks SP U.S. BMI Banks SP 500
Source: SP Capital IQ Pro.

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
LTM
2022
U.S. 18.4%12.0% 6.9% 6.3% 5.4% 4.3% 5.5% 7.5% 7.5% 6.1% 10.0% 9.6% 9.3% 5.5% 6.9% 6.9%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Core
Deposit
Premiums
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
LTM
2022
U.S. 228% 196% 145% 141% 132% 130% 134% 155% 148% 143% 170% 178% 168% 150% 152% 157%
0%
50%
100%
150%
200%
250%
Price
/
Tangible
Book
Value
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
LTM
2022
U.S. 22.1 19.9 19.3 21.7 21.9 17.0 16.5 17.5 18.8 18.1 19.5 22.4 16.3 13.9 14.5 13.7
0
5
10
15
20
25
30
Price
/
Last
12
Months
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 12.2x 187% 7.0% 11 143.0 689,345 13.2%
Midwest 14.5x 153% 7.8% 53 97.2 218,209 9.8%
Northeast 14.1x 118% 3.2% 5 60.7 442,468 7.8%
Southeast 13.0x 161% 6.4% 24 67.6 355,747 15.5%
West 13.0x 161% 7.5% 18 81.8 540,658 13.4%
National Community
Banks
13.7x 157% 6.9% 111 88.6 333,779 11.2%
Median Valuation Multiples for MA Deals
Target Banks’ Assets $5B and LTM ROE 5%, 12 months ended July 26, 2022
Median Core Deposit Premiums
Target Banks’ Assets $5B and LTM ROE 5%
Median Price/Tangible Book Value Multiples
Median Price/Earnings Multiples

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.
© 2022 Mercer Capital // Data provided by SP Global Market Intelligence 8
Mercer Capital’s
Regional Public
Bank Peer Reports
Atlantic Coast Midwest Northeast
Southeast West

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, ASA
901.270.7250
stantone@mercercapital.com
Mary Grace Arehart, CFA
901.322.9720
arehartm@mercercapital.com
Mary Jane McCaghren
214.206.3796
mccaghrenm@mercercapital.com
William C.Tobermann, CFA
901.322.9783
tobermannw@mercercapital.com
Heath A. Hamby, CFA
615.457.8723
hambyh@mercercapital.com
Copyright © 2022 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
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