June 16, 2004
Banks in Pacific Northwest, Hawaii prove to be a boon for shareholders
Banks headquartered in Alaska, Hawaii, Idaho, Oregon and Washington had an average return on equity of 12 percent in 2003, making them wise investments for investors, new research shows.
So why do these banks give investors a hefty bang for their buck?
These financial institutions have done an excellent job of managing their operating costs such as employee wages and benefits, according to Alan Hess, a University of Washington professor of finance and business economics. The median return on equity, an overall measure of financial performance that relates earnings to the amount of money investors have put into the bank, was 12 percent. That is slightly more than the Federal Reserve Bank of San Francisco’s numbers for small banks nationwide (11.6 percent return on equity) and all small banks headquartered in the Federal Reserve’s 12th district (11.9 percent return on equity).
By comparison, an investor who purchased a one-year treasury security at the beginning of 2003 would have earned only 1.4 percent. The Standard & Poor’s 500-stock index, one of the most commonly used benchmarks of the overall stock market, yielded investors a 29 percent rate of return during the same period.
Hess and several honors students analyzed balance sheets and income statements of the financial institutions headquartered in the five states. Of those 115 banks, only four did not have positive earnings. Washington Mutual, by far the largest bank headquartered in the Northwest, had the third-highest performance with a return of 24 percent. Bank of the Cascades, located in Bend, Ore., and Pierce Commercial Bank in Tacoma, Wash., topped the efficiency ratings charts and had respective rates of return on equity of 26 and 25 percent.
Banks with low efficiency ratios, the ones that are best at controlling operating expenses, had the highest returns. Generally, said Hess, banks with efficiency ratios less than 63 percent had returns greater than the median return of 12 percent. The median bank spent 63 percent of its net revenue on operating expenses.
Hess’s research also indicated that while economic returns varied widely, profitability was not determined by bank size — small banks were just as likely as large banks to perform well. Additionally, he found that the rate of return on equity for banks whose headquarters are in the Pacific Northwest has consistently made sizeable gains during the past three years. In Washington state, for example, that figure has increased from just 3 percent in 2000 to 12 percent in 2003.
“If a bank can control its expenses, it has a high margin and therefore a high rate of return on equity,” Hess said. “This efficiency ratio is typically calculated by banking institutions as non-interest expenses divided into revenue and provides investors with a window into how effectively they operate.”
What was fairly surprising, said Hess, was that although overall profits were strong, banks displayed considerable diversity in performance. For example, the lowest-performing bank had a return of minus 1.65 percent, and the highest-performing bank had a return of 26 percent. Both of these banks, First Consumers National Bank and Bank of the Cascades, respectively, are located in Oregon. The six commercial banks in Alaska had the least diversity of performance with returns ranging from 6 percent to 16 percent.
The 10 most profitable banks in Alaska, Hawaii, Idaho and Washington in 2003 are Bank of the Cascades, Bend, Ore., Pierce Commercial Bank, Tacoma, Wash., Washington Mutual, Seattle, Fife Commercial Bank, Fife, Wash., Frontier Bank, Everett, Wash., Farmers & Merchants State Bank, Boise, Idaho, Bank of America Oregon National Association, Portland, Ore., Central Pacific Bank, Honolulu, Hawaii, and Silver Falls Bank, Silverton, Ore., and Security State Bank of Centralia, Wash.
The state-by-state breakdown of rates of return on equity is:
- Alaska: 2002, 11.6 percent; 2003, 11.7 percent
- Hawaii: 2002, 10.2 percent; 2003, 12.5 percent
- Idaho: 2002, 7.4 percent; 2003, 10.4 percent
- Washington: 2002, 11.5 percent; 2003, 12 percent
Hess added that employee costs constitute a large component of the efficiency ratio. While banks differ in whether they earn their income from interest revenue as opposed to non-interest revenue, this difference is much less important than their cost control as a distinguishing feature of their overall performance.
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For more information, contact Hess at (206) 543-4579, (206) 729-2500 or hess@u.washington.edu
