Sources of Bank Charter Values

Frederick Furlongand

Simon H. KwanFederal Reserve Bank of San Francisco

Disclaimer: Do not represent the views of the Federal Reserve

Rebound in BHC charter value ratiosRebound in BHC charter value ratiosFigure 1: Median Charter Value Ratios for BHCs

(Ratio of Market-Value Equity to Book-Value Equity)

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FDICIAReagle-Neal Passed

GLB

Outline

• Potential reasons for positive charter values in banking

• Developments in U. S. banking that may have affected charter values

• Data and empirical model

• Empirical findings on factor affecting charter value ratios

Bank-specific factors affecting CV

• Funding• Federal safety net, reliance on insured deposits• Other sources of funding

• Transactions services (access to payments system)• Portfolio lending

• Synergies in deposit taking and lending

• Other Non-interest income – Credit services—e.g. loan commitments– Economies of scope in financial services

• Operational efficiency– Economies of scale– X efficiency

Developments in U. S. banking that may have affected charter values

• Restructuring

• Financial innovation

• Adoption of technology affecting operational efficiency

• Legislative, regulatory, supervisory initiatives to limit conjectural guarantees from federal safety net

Empirical Model

CVi t = 0 + 1 X1it + 2 X2it + 3 X3it + 4 X4it + 5 X5it + it

j (j = 1, 2, 3, 4) is a vector of coefficients, and is an error term

CV = market-value equity / book-value equity

Empirical Model

X1 is a vector of deposit variables

TRAN = transactions deposits / total liabilities

NONTRAN = small-denomination nontransactions deposits / total

liabilities

CD = large certificate of deposits / total liabilities

X2 represents a vector of variables that are sources of bank interest

revenue

CILOAN = commercial loans / total assets

CSLOAN = consumer loans / total assets

RELOAN = real estate loans / total assets

Empirical Model

X3 represents relative importance of activities generating non-interest income

NIC = non-interest revenue / (non-interest revenue + net interest income)

X4 is a vector of variable for size and operational efficiency

LNASSETS = log(total book-value of assets)

OPEFFCY= (non-interest revenue + net interest income)/non-interest expenses

EFFCY = residual from

OPEFFCYi t = 0t + 1t X1it + 2t X2it + 3t X3it + 4 t LNASSETSit + it

Empirical Model

X5 is a vector of macro financial market variables

SP500 = SP500 index

3MTREAS = 3-month Treasury bill rate

10YTRREAS =10-year Treasury bond rate

Data• Federal Reserve Y-9C data

• Sample period: 1986 Q2 to 2003 Q4– Sub-periods: 1986 Q2 to 1994 Q4

1995 Q1 to 2003 Q4

• BHC stock price data from CRSP

• Final sample: 624 BHCs with 22,338 firm-quarter obs.

• Size classes: Large (top 10th percentile by assets) Medium (50th to 90th percentile ) Small (bottom 50th percentile)

Stock index and bank charter value ratiosS&P500 Index and Charter Values of BHCs

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CV LargeBHCs

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S&P 500

CVs (left scale)S&P500 (right scale)

BHC-specific and macro financial effects

R-squares1986-2003 1986-1994 1995-2003

Large Full model 0.64 0.41 0.5BHCs BHC specific 0.35 0.33 0.33

Macro financial only 0.33 0.1 0.16

Medium Full model 0.27 0.09 0.16BHCs BHC specific 0.12 0.03 0.14

Macro financial only 0.24 0.06 0.04

Small Full model 0.17 0.16 0.08BHCs BHC specific 0.1 0.14 0.07

Macro financial only 0.1 0.01 0.01

BHC-specific effects—deposit shares

Effects of Deposit Shares1986-2003 1986-1994 1995-2003

Large TRAN 1.166 ** 1.128 *** 1.030 ***BHCs NONTRAN 0.205 * 0.287 *** 0.544 **

CD -0.874 *** 0.176 -2.662 ***

Medium TRAN 0.364 *** 0.455 *** 0.567 ***BHCs NONTRAN 0.280 *** -0.131 0.665 ***

CD 0.069 0.015 0.136

Small TRAN 0.324 *** 0.305 *** 0.606 ***BHCs NONTRAN 0.401 *** 0.590 *** 0.330 **

CD 0.450 *** 0.905 *** -0.118

Declining transactions deposit shares

Transactions Deposit Shares for Publicly Held BHCs

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Transactions deposits as share of liabilities

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BHC-specific effects—loan shares

Effects of Loan Shares1986-2003 1986-1994 1995-2003

Large CILOAN -1.485 *** -0.709 *** -2.070 ***BHCs CSLOAN 2.305 *** 1.943 *** 2.063 ***

RELOAN -1.438 *** -0.840 *** -2.256 ***

Medium CILOAN -0.096 -0.166 -0.243BHCs CSLOAN 0.073 0.475 *** -1.031 ***

RELOAN 0.202 ** 0.110 0.321 ***

Small CILOAN -0.231 * -0.453 *** 0.236BHCs CSLOAN -0.408 *** -0.362 ** -0.543 ***

RELOAN -0.004 -0.375 *** 0.207 **

Real estate loan shares

Real Estate Loans Shares for Publicly Traded BHCs

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Ratio of real estate loans to total assets

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BHC-specific effects—non-interest shares

Effect of Non-intest Income Shares1986-2003 1986-1994 1995-2003

LargeBHCs NONINTINC 1.790*** 0.893*** 2.487***

MediumBHCs NONINTINC -0.091 -0.656*** 0.357*

Small BHCs NONINTINC -0.036 -0.947*** -0.011

BHC-specific effects—non-interest shares

Effects of Non-interest Income Shares 1995-2003Large BHCs

NONINTINC 95-96 1.312 ***NONINTINC 97-99 3.576 ***NONINTINC 2000-03 2.339 ***

Medium BHCsNONINTINC 95-96 -0.467 **NONINTINC 97-99 1.692 ***NONINTINC 2000-03 -0.268

Small BHCsNONINTINC 95-96 -2.737 ***NONINTINC 97-99 0.373NONINTINC 2000-03 -0.125

Rising non-interest income sharesNon-interest Income as a Share of Operating

Income for Publicly Held BHCs

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Median values of ratios of non-interest income to (non-interest income + net interest income)

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BHC-specific effects—size & efficiency

Effects of Size and Efficiency1986-2003 1986-1994 1995-2003

Large LNASSETS -0.215 *** -0.125 *** -0.363 ***BHCs EFFCY 0.933 *** 0.916 *** 0.947 ***

Medium LNASSETS 0.081 *** 0.003 0.193 ***BHCs EFFCY 0.159 0.084 0.674 ***

Small LNASSETS 0.152 *** 0.112 *** 0.207 ***BHCs EFFCY 0.696 *** 0.721 *** 0.680 ***

BHC-specific effects—size & efficiency

Effects of Size and Efficiency1986-2003 1986-1994 1995-2003

Large LNASSETS -0.215 *** -0.125 *** -0.363 ***BHCs EFFCY 0.933 *** 0.916 *** 0.947 ***

Medium LNASSETS 0.081 *** 0.003 0.193 ***BHCs EFFCY 0.159 0.084 0.674 ***

Small LNASSETS 0.152 *** 0.112 *** 0.207 ***BHCs EFFCY 0.696 *** 0.721 *** 0.680 ***

Rise in efficiencyEfficiency Ratios for Publicly Held BHCs

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Median values of ratios of (non-interest income + net interest income) to non-interest expenses

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Conclusions

• Bank-specific characteristics– Deposits: consistent positive effects from transactions and

core deposits on CV ratios

• No change in marginal effects, decline in shares – Portfolio lending: only consistent positive effect on CV ratios

from consumer lending for large BHCs – Non-interest revenues: consistent positive effect on CV ratio

for large BHCs• Increase in marginal effect, rise in share

– CV ratios related to measure of efficiency• No change in marginal effect, rise in measured efficiency

• Macro financial variable appear to have contributed to movements and some of the net rise in measured CV ratios