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What do bank investors and buyers look for during a down market?

By: Monte Giese and Tom Hayes

Bank stocks saw an unprecedented increase from the second quarter of 2000 until the end of 2006. The NASDAQ Bank Index was up 128 percent during the time frame, versus an increase of 19.3 percent for the Dow Jones Industrial Average and a decrease of 2.5 percent for the S&P 500. What is even more impressive is NASDAQ and NYSE publicly traded banks in the Western U.S. (Alaska, Arizona, California, Hawaii, Idaho, Nevada, New Mexico, Oregon, Utah and Washington) outperformed the NASDAQ Bank Index, increasing by 180 percent on average from the second quarter of 2000 until the end of 2006.

This period of relative prosperity for banks was preceded by a significant underperformance of banks with the NASDAQ Bank Index down 28.1 percent from the beginning of 1998 until the second quarter of 2000. The late 1990s downturn compares to the recent downturn in bank stocks in which the NASDAQ Bank Index was down 11.8 percent from the beginning of 2007, while the S&P 500 and NASDAQ Composite Index were up 4 percent and 7.5 percent, respectively.

While it is tough for bank stocks to buck the trend of the entire industry (only 24 percent of bank stocks increased in value from 1998 to 2000), it is possible for banks to outperform their peers in this most recent downturn. It is important to look back at the characteristics of the banks that delivered the best relative performance during the last market downturn.

Publicly traded banks in the last downturn

In our analysis, we attempted to identify what measures resulted in premium valuations for certain banks during the last downturn. We looked at an 11-year period: a few years before the last downturn (1996-1997), the downturn (1998-1999), and the period between the last downturn and the most recent downturn (2000-2006).

We ranked the banks into quartiles based on average price-to-book multiples over the time frames and Table 1 summarizes these rankings over the three time periods.

The most important factor that drives stock price performance is a bank’s earnings performance. The data in the table shows that investors, all things being equal, are willing to pay premium multiples for banks with higher returns on assets and returns on equity.

While the above metrics are clearly important to investors, it is evident that they did not have a major influence on bank valuation multiples during the last market downturn.

Return on equity is very important to investors, probably the single most important metric. Related to return on equity are net interest margin and the efficiency ratio, so it makes sense that they would be indicators of valuation.

Also, banks with higher loan loss reserve levels were valued at higher multiples by investors. Finally, the higher core deposit levels were found in banks with higher multiples, highlighting the value of a stable, low-cost funding source.
Bank mergers and acquisitions in the last downturn

We also examined bank merger and acquisition multiples paid during the last downturn. The bank M&A multiple downturn lags the downturn in the trading multiples by approximately 12 months and the downward trend lasts approximately 24 months longer than the trading multiple decline.

Forty-eight percent of the transactions in the 1996-1998 time frame were done using pooling accounting, which went away after June 30, 2001, while only 36 percent of the deals in the 1999-2001 time period were done using the pooling method. The pooling method of accounting allowed for higher purchase prices to be paid without the addition of goodwill to the buyer’s balance sheet.

Again, the most important factor that drives acquisition multiples is a bank’s earnings performance. Buyers are willing to pay more for higher-performing institutions.


It appears that investors and banks themselves look for the same attributes in high-performance institutions. We will not know how long this current bank stock downturn will last, but there are several things bank directors can focus on to maximize value, whether it is in the value of the stock in trading minority positions or in selling the entire institution:

Monte Giese is a managing director and Tom Hayes is a vice president in D.A. Davidson & Co.’s Financial Institutions Group investment banking practice located in Great Falls, Mont. They can be reached at 406-791-7421, or via email at mgiese(at) or thayes(at)

Copyright October-November 2007 Western Banking (BankNews Publications)