Merchants Bancorp takes 1st place in US bank performance ranking

Introduction

A gusher of revenues from cyclical or temporary businesses helped propel three institutions to the top of S&P Global Market Intelligence's performance ranking of public U.S. banks with more than $10 billion of assets.

But the banks have forecast that diversified business models will keep them on a strong growth trajectory as a shift in the interest rate environment delivers what is expected to be a broad tailwind for the industry. Two of the banks also have good track records in the performance rankings, earning top slots in previous years.

About this analysis

S&P Global Market Intelligence ranked the financial performance of operating U.S. public banks with greater than $10 billion in total assets at Dec. 31, 2021, and trading on the Nasdaq, NYSE or NYSEAM. Mutual holding companies and other operating subsidiaries are excluded. Industries are classified according to the Global Industry Classification Standard of S&P Global Market Intelligence.

Companies were ranked based on three major categories, using calendar-year data as well as GAAP data unless otherwise noted: growth, weighted at 35%; profitability, weighted at 35%; and safety and soundness, weighted at 30%.

The two growth metrics were pre-provision EPS (20%) and operating revenue (15%). The 2021 change was used for EPS and the lesser of 2021 change and median annual change between 2017 and 2021 was used for operating revenue.

The two profitability metrics were 2021 return on average tangible common equity (20%) and 2021 efficiency ratio (15%). For return on average tangible common equity, GAAP data was used when available; otherwise, regulatory data was used.

The two safety and soundness metrics were leverage ratio at Dec. 31, 2021, (15%) and net charge-offs-to-average loans on an average annual basis between 2017 and 2021 (15%). For leverage ratio, GAAP data was used when available; otherwise, regulatory data was used.

S&P Global Market Intelligence measured each company's standard deviation from the mean value for the six financial metrics. Ceilings and floors were implemented for those standard deviations so that significant outliers would not skew the analysis. The capped standard deviations then were weighted according to the above percentages and aggregated to determine a relative performance score on a scale from -200 to 200.

Carmel, Ind.-based Merchants Bancorp took first place in the 2021 ranking. The $11.28 billion-asset institution was also among the top three in S&P Global Market Intelligence's 2019 and 2020 community bank rankings.

Merchants operates three principal segments: a multifamily mortgage business that specializes in originating and selling government-backed loans, mortgage warehousing and traditional community banking. Mortgage warehousing net income at the company declined 10.5% in 2021 after more than doubling the year before as industry volume subsided, but the bank's two other segments continued to produce strong growth.

Merchants' total operating revenue has grown by at least 21% annually since 2017, performance that was one of the main drivers of the bank's score in the 2021 ranking. The bank also earned top marks on profitability and strong scores across the other metrics considered, and analysts at Raymond James identified it in March as one of the strongest asset-sensitive plays in the bank sector.

In its earnings report in January, Merchants attributed its performance to a "business model that has focused on conservative underwriting, cost efficiency, and holding short-duration assets by originating loans to be sold in the secondary market."

Western Alliance Bancorp. took second place in the 2021 ranking after first-place finishes in performance rankings of the 50 biggest public U.S. banks for 2019 and 2020.

The rapidly growing bank, with branches in major metropolitan areas in the Southwest, paid $1.22 billion to acquire AmeriHome Mortgage Co. LLC in early 2021, driving a 673.5% increase in noninterest income in 2021 to $375.1 million.

But noninterest income fell 29.0% sequentially in the 2021 fourth quarter as mortgage production declined 4.4% to $18.3 billion and the bank reported a gain on sale margin of 28 basis points for the period, compared with 35 basis points in the third quarter and 41 basis points for the full year.

The bank said it plans to pivot away from mortgages it sells to Federal National Mortgage Association and Federal Home Loan Mortgage Corp. and toward higher-margin loans and that the business is producing attractive assets that are contributing to strong growth in its loan portfolio.

Western Alliance's net loans held for investment increased 45.0% in 2021 to $38.82 billion, including 27.7% growth in commercial and industrial to $18.30 billion. The bank projected loan growth of more than $2 billion a quarter in 2022, or more than 20% for the year.

It also disclosed that an instantaneous jump in interest rates of 100 basis points would translate into a 4.6% increase in net interest income, though about half the impact would be offset by factors like lower gain-on-sale margins.

Net income available to common shareholders at third-place Customers Bancorp Inc. surged more than 150% in 2021 to $300.1 million, fueled by $195.1 million of earnings from its leading participation in the Paycheck Protection Program.

The bank attributed its success with the federal small business rescue effort — its over $10 billion of funded loans exceeded many much larger banks — to its financial technology orientation and partnerships.

Customers launched a blockchain-based initiative in October 2021 under which commercial depositors can transfer and redeem its Customers Bank Instant Token. It signed up an initial group of 25 clients comprising cryptocurrency brokers and exchanges and other digital asset enterprises, generating $1.9 billion of deposits as of the end of 2021.

Deposits from the cryptocurrency platform are replacing deposits leaving Customers as a part of its spinoff of BM Technologies Inc., a neobank it launched in 2015.

Excluding PPP, total loans were up 0.4% in 2021 to $11.32 billion, with growth in commercial and industrial partially offsetting a decline in mortgage warehouse. The bank said its pipeline is full and projected double-digit loan growth in 2022 propelled by specialty businesses like lender finance.

It also projected core EPS, excluding PPP, of $4.75 to $5.00 in 2022 and "well over" $6.00 in 2023, up from $4.41 in 2021.

Shares at each of the top-three ranked banks also were among the best market performers in 2021, led by a 259.6% total return at Customers.

Customers' stock appears to have benefited in part from investor enthusiasm for crypto. (Western Alliance also plans to launch a digital token through a partnership with Tassat Group LLC, the same platform used by Customers.)

In 2022 through March 18, however, the three companies have underperformed a 2.6% decline in the S&P U.S. BMI Banks Index, with Western Alliance dropping 18.3%

Janney Montgomery Scott analyst Timothy Coffey attributed Western Alliance's recent share performance to credit concerns over its strong loan growth as the economic outlook has become more uncertain.

But Coffey argued in a note on March 10 that the bank's "addition of mortgage origination capabilities in 2021 reduces the company's credit risk profile and mortgage loans are likely to remain a significant driver of loan growth." He maintained his "buy" rating on the stock.