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Building Franchise Value - What Matters Most
All banks, both private and public, enjoy two types of returns – current income (which is typically measured quarterly) and long-term capital appreciation, which is measured both as the growth in book value as well as the market value of the enterprise, which typically gains a franchise value premium.
Analysis by Steven Alexopoulos of JPMorgan Securities shows that, over time, the three most successful paths to yield franchise value premiums are:
• Organic growth
• Common equity issuer
• Balance sheet compounder
Other strategic paths, most notably positive operating leverage stories, capital returns and historically acquisitive banks, do not drive long-term franchise value appreciation as effectively.
Alexopoulos studied mid-size banks over a period of ten years plus. His study was outcome-based, spanning multiple time periods, and covering banks of all sizes. He concluded the following:
1. The top five performers of his midsize bank coverage universe far surpassed the rest of the group in revenue growth (15.5% vs. 4.7% for the bottom five), Reported EPS growth (15.2% vs. 1.4% and TBV growth (14.2% vs. 6.6%). The operative word here is GROWTH.
2. Put differently:
a. Revenue growth was 3X higher at outperformers
b. Reported EPS growth was 15X higher
c. TBV growth was 2X higher
3. Metrics that mattered far less included:
a. Capital return
b. Low efficiency ratio
c. High fee income ratio (a surprise to me, I confess)
d. Positive leverage
4. Other characteristics of outperformers:
a. They don’t buy back stock which dilutes Tangible Book Value growth
b. They grow organically and don’t pursue M&A
c. They have a much stronger expense growth as they invest in the business
d. Have lower dividend payout ratios
e. Have lower NPA ratios (said differently, better asset quality)
Based upon these finding, Alexopoulos concluded that the strongest path to success is offering a premium customer experience while operating in markets filled with weak competitors. He identified high Net Promoter Score (NPS) banks in low NPS markets as a proxy to measure that hypothesis. His thesis: consider an entirely new scale to measure the bank’s client satisfaction as compared to its primary markets. The scale he constructed compares NPS scores with forward P/E for the 50 largest banks in the country. The bargains are among low 2022 P/E multiples that enjoy high NPS, while the overvalued group has high 2022 P/E multiples combined with low NPS.
This is an innovative and new way of looking at bank valuations and strategies to optimize long-term performance. It combines traditional banking premises (provide superior service and price and underwrite effectively and all will be well) with the new definition of customer experience, which incorporates technology elements into the CX experience to truly excel in your NPS results. I believe this is the path to success for midsize and SuperCommunity banks. Our value proposition remains true to our roots, but we cannot ignore the shifting drivers of customer satisfaction. Marrying the tried-and-true strategic premise of superior service and customer experience with technological innovation on the customers’ terms is the sweet spot for midsize banks nationwide.
New in the Nest:
This column will offer fool proof recipes, restaurant suggestions and other foodie tidbits for your consideration and consumption.
You can find more tasty recipes in the Recipe Archive