Review & Outlook

Our take on the investing, financial, & economic themes of the day

For Big Banks, $100bn in Government Fines is a Small Price to Pay for $590bn in Government Subsidies

Earlier this week the Financial Times tallied up how much Wall Street banks and their foreign rivals have have paid in fines since the financial crisis.  The total is about $100 billion.  In this chart the FT lists the top four banks in terms of fines paid:

top fined banks

$100 billion is a lot of money.  It’s not a lot of money, however, compared with the various estimates of the implicit government subsidy–to the tune of $590 billion–given to big banks by treating them as “too big to fail.”  According to an International Monetary Fund (IMF) study released today, its Global Financial Stability Report, banks that are “too important to fail” (TITF), to use its more genteel term, benefit by this amount from artificially low borrowing costs, which they enjoy on the assumption that  governments will bail out their creditors if the banks get into trouble.  These lower borrowing costs translate into more profitable margins for the banks, courtesy of the extra risk assumed by taxpayers.   The IMF study says that TITF banks benefit unevenly: big banks in the US get implicit subsidies of $15-$70 billion; $25-$110 billion in Japan; and $90-300 billion in Europe.  Here is the IMF’s representation of how implicit subsidy helps bank balance sheets:

TITF

 

In a similar vein, in October 2013 Bloomberg produced the following graphic which shows the extent to which big bank profitability depends upon the implicit government subsidy.  (Bloomberg relied upon data from a previous paper written by researchers at the IMF and the University of Mainz.)

Bloomberg TBTF

It’s interesting to see that by some measures in the IMF report, U.S. and Japanese big banks have actually had their implicit subsidy decreased from its height during the financial crisis, whereas big banks in the U.K., Switzerland, and the eurozone have only seen increasing government support (see p. 19).  The massive subsidy enjoyed by large banks is one of the main factors driving bank consolidation, since small banks that aren’t “systemically important” don’t get the implicit government backstop.  Thus it isn’t surprising that in the entire U.S., the only de novo bank started up in the past few years has been a tiny Amish bank in rural Pennsylvania.

no of banks

These trends indicate that it is difficult for small banks to compete.  But it is possible.  One bank that has managed to buck the trend is a regional bank that’s based in Arkansas, Bank of the Ozarks (OZRK), that has a market capitalization of $2.5 billion, and which we own in the O’Brien Green Small-Capitalization Stock Fund, L.P.

Compared to most of its competitors, Ozarks has performed exceptionally well and sailed through the 2008-2009 financial crisis without difficulties.  Today Ozarks declared a $0.23 per share quarterly dividend, which was a 4.5% increase from prior dividend of $0.22.  It has an experienced and dedicated management, strong history of disciplined asset growth through acquisitions, high net interest margins, and steady dividend increases.  Many investors are attracted to companies with a high absolute yield, but dividend growth rate is often a better indicator of long-term value.

Bank of the Ozarks (OZRK)

div yield

Although Ozarks still garners investor favor (Barron’s recommended it as recently as December 2013), its price appreciation over the past two years has resulted in a pretty high valuation, particularly for a bank: it now trades at 28.4 times earnings (ttm).  We don’t have plans to sell, but we would be reluctant to add to the position at its current price.  In any case, even though it’s increasingly difficult for small banks to thrive, the performance of the Bank of the Ozarks shows that it can still be done.