June 16, 2003
Washington state financial institutions yield substantial returns for investors
In the wake of the dot-com bust, banks and savings and loan associations headquartered in Washington state proved to be smart investments in 2002, according to a University of Washington expert in banking and financial markets.
“Our research shows that Washington state banks were financially profitable,” said Alan Hess, a UW professor of finance and business economics.
Hess and several honors students analyzed balance sheets and income statements of most of the financial institutions based in the state. They found that of 52 banks and thrifts studied, 49 yielded positive economic returns. The three highest-performing banks had average returns that exceeded their costs of capital by 17 percentage points while the three lowest-performing banks had negative economic returns.
“Banks typically earn their cost of capital, which keeps investors content because that means shareholders are compensated for the risks they bear in owning the bank’s stock. But with banks producing an average rate of return of 8 percent more than their cost of capital, people who owned stock in Washington’s banks last year should be pleased,” said Hess.
Comparatively, said Hess, a conservative investor who at the beginning of 2002 allocated 75 percent of his investment to U.S. Treasury securities and 25 percent to the Standard & Poor’s 500-stock index could have expected to earn about 3.5 percent.
The research also showed 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. According to Hess, the relatively high profitability rate of Washington state’s banks was due to a combination of efficiency of operations and low interest rates.
“Cost control is the primary factor that determines whether a bank will be a high or low performer,” said Hess. “A bank’s efficiency ratio compares its non-interest expenses to a measure of its revenue. The efficiency ratio for Washington state banks averaged 57 percent and varied between 65 percent for the least-efficient bank and 50 percent for the most profitable.”
The 10 most-profitable banks based in Washington state in 2002 are Fife Commercial Bank, Fife; Kitsap Bank, Port Orchard; Frontier Bank, Everett; The Commerce Bank of Washington, Seattle; Security State Bank, Centralia; Islanders Bank, Friday Harbor; Bank of the Pacific, Aberdeen; AmericanWest Bank, Ephrata; First Mutual Bank, Bellevue; and Washington First International Bank, Seattle.
Additionally, the state’s three largest banks, Washington Mutual, Washington Federal, and Pacific Northwest Bank also earned high returns. They generated economic returns that were 9 percentage points greater than returns investors could have reasonably expected to receive.
The research also found that:
? Top-performing banks had equity returns of 20 percent, while the lowest performers had equity returns of less than 1 percent. Equity returns averaged 11.5 percent.
? Average economic rates of return were 2 percent in 2001 and 3 percent in 2000 — a strong financial performance.
Hess, on the UW Business School faculty since 1967, said the research is based on the theory that financial performance should be measured relative to the rate of return that could be earned on an investment of equal risk, and not just on the raw rate of return.
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For more information, contact Hess at (206) 543-4579 or hess@u.washington.edu
