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Book to understand banking industry and their financial statements


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Any books which can help me understand banking industry and how to read and interpret their financial statement?

 

I understand their might not be just one book. Good way would be to understand industry and learn accounting seperately to apply to it. I am looking for more of things to consider or different facets of the business and its balance sheet.

 

Just wanted to hear thoughts about board members as there is lot of discussion about banking sector on this board yet someone like WEB is still able to spot amortization charge on WFC income statement which he claimed no one talks about including analysts. 

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There is a book called "bank management" that I have heard is good.  If you haven't already read it it may be useful to read Buffett's commentary on Illinois National from the early days of Berkshire.  I don't know if they have those old letters on the website but they have them in one of John Train's books.  I think it was "money masters of our time".

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Don't bother as they are all black boxes these days.  Either you are investing in the very large institutions with brand or with sticky deposits/relationships or you are investing in smaller shops that are really key man investments.  Of course there are exceptions, but if anyone knows how to read bank financial statements -- please stand up (I gave up around '96-'97).  It would appear that neither the regulators know how, or even some CEOs.  Anyway, as a banker today you are mostly beholden to the FED for the next 10-years, at least.

 

Cheers

JEast

 

Disclosure: I do own some bank stocks presently.

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Don't bother as they are all black boxes these days.  Either you are investing in the very large institutions with brand or with sticky deposits/relationships or you are investing in smaller shops that are really key man investments.  Of course there are exceptions, but if anyone knows how to read bank financial statements -- please stand up (I gave up around '96-'97).  It would appear that neither the regulators know how, or even some CEOs.  Anyway, as a banker today you are mostly beholden to the FED for the next 10-years, at least.

 

Cheers

JEast

 

Disclosure: I do own some bank stocks presently.

 

This is a point I never understand, at least as it relates to community banks.  A community bank has 2 basic assets - loans and securities.  It has one main liability - deposits.  No, we can't see any of these and examine them so we essentially need to assume that the values being placed on them by management are correct or haircut them in some generic way we find appropriate.  But how is this different than really any company?  Is FFH not a black box?  BRK?  Why is an insurance company not a black box?  Seems kind of the same at a macro level to me.

 

And take any other kind of company.  Is a retailer that says it has $50 mil in inventory not a black box?  Can we examine the inventory and make our own determination of it's value?  We don't even know what it is.  Is it blue jeans that are "classic" and will always be able to be sold or is it a warehouse full of "Frankie Says Relax" t-shirts?

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This is a point I never understand, at least as it relates to community banks.  A community bank has 2 basic assets - loans and securities.  It has one main liability - deposits.  No, we can't see any of these and examine them so we essentially need to assume that the values being placed on them by management are correct or haircut them in some generic way we find appropriate.  But how is this different than really any company?  Is FFH not a black box?  BRK?  Why is an insurance company not a black box?  Seems kind of the same at a macro level to me.

 

Kraven,

here is what I wrote to Christopher1 just yesterday:

 

Have you ever made a comparison between BNP Paribas (or any other large bank) and Fairfax? BNP Paribas has a ratio total assets vs. tangible equity of 26, for Fairfax that ratio is 3.4. It means that BNP Paribas has put to risk $26 for each $1 it owns, while Fairfax has put to risk $3.4 for each $1 it owns. Moreover Fairfax has put those $3.4 to risk through HWIC, which is a very small corporation, and therefore very easy to manage and control. Doesn’t it strike you as a comparison between two utterly different risk profiles?

I also tend to compare the equity of an insurance company to the equity of a bank corporation, the float of an insurance company to the deposits of a bank corporation (though their costs are demonstrably different), and the debt of an insurance company to the debt of a bank corporation. And that is because both float and deposits are liabilities whose risk profile is much safer than long-term debt. Now, please consider, for Fairfax total assets are funded this way: 29.3% equity, 60.8% float, 9.9% debt. Instead, for BNP Paribas total assets are funded this way: 3.8% equity, 29% deposits, 67.2% debt.

 

If Fairfax and BNP Paribas are both black boxes, they certainly are two very different black boxes! :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

 

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The points above are understandable, but my general observation is relative to understanding the banking industry.  For the very large institutions they are indeed just black boxes, just ask Bill Miller as he was playing reversion to the mean.  I agree with his strategy, but it had nothing to do about reading the bank's balance sheet because one (for the most part) can not perform due diligence with any true understanding.

 

Of course all investments are black boxes to some degree, inventory, accounts receivable, deferred tax asset, ... the list goes on.  But unlike banks though, you usually don't have the risk of truly blowing up though the balance sheet looked reasonable.  Analyzing a bank's balance sheet more than just the bare minimum basics (in my view) is time that could be used analyzing something more tangible.  For example, just wait for a community bank to fall to 50% of TBV and buy -- no analyzing need -- in the Benjamin Graham spirt.

 

Cheers

JEast

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This is a point I never understand, at least as it relates to community banks.  A community bank has 2 basic assets - loans and securities.  It has one main liability - deposits.  No, we can't see any of these and examine them so we essentially need to assume that the values being placed on them by management are correct or haircut them in some generic way we find appropriate.  But how is this different than really any company?  Is FFH not a black box?  BRK?  Why is an insurance company not a black box?  Seems kind of the same at a macro level to me.

 

Kraven,

here is what I wrote to Christopher1 just yesterday:

 

Have you ever made a comparison between BNP Paribas (or any other large bank) and Fairfax? BNP Paribas has a ratio total assets vs. tangible equity of 26, for Fairfax that ratio is 3.4. It means that BNP Paribas has put to risk $26 for each $1 it owns, while Fairfax has put to risk $3.4 for each $1 it owns. Moreover Fairfax has put those $3.4 to risk through HWIC, which is a very small corporation, and therefore very easy to manage and control. Doesn’t it strike you as a comparison between two utterly different risk profiles?

I also tend to compare the equity of an insurance company to the equity of a bank corporation, the float of an insurance company to the deposits of a bank corporation (though their costs are demonstrably different), and the debt of an insurance company to the debt of a bank corporation. And that is because both float and deposits are liabilities whose risk profile is much safer than long-term debt. Now, please consider, for Fairfax total assets are funded this way: 29.3% equity, 60.8% float, 9.9% debt. Instead, for BNP Paribas total assets are funded this way: 3.8% equity, 29% deposits, 67.2% debt.

 

If Fairfax and BNP Paribas are both black boxes, they certainly are two very different black boxes! :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

Gio, your points are well taken, but it's a bit of a strawman argument.  BNP is a weaker bank, so you've compared two things are extremes.  I could say look at VERF compared to FFH.  VERF is a tiny community bank with about $4 of tangible assets for each dollar of tangible equity.  It is almost completely funded with deposits and only $5 mil in debt.  Of course it's impossible to buy.

 

I am not saying banks and insurance companies or FFH, in particular, are identical investments.  But my point stands.  If a bank is a black box, so is an insurance company.  It doesn't matter to me that one might be more leveraged than another.  Balance a bowling ball on a pin and some level it doesn't matter how thick that pin is (unless it is not really a pin at all but something else with a point on the end).

 

So BNP and FFH may be different kinds of black boxes, but at the end of the day one still has to rely on the numbers as they stated in the financials.  Nothing more or less.

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The points above are understandable, but my general observation is relative to understanding the banking industry.  For the very large institutions they are indeed just black boxes, just ask Bill Miller as he was playing reversion to the mean.  I agree with his strategy, but it had nothing to do about reading the bank's balance sheet because one (for the most part) can not perform due diligence with any true understanding.

 

Of course all investments are black boxes to some degree, inventory, accounts receivable, deferred tax asset, ... the list goes on.  But unlike banks though, you usually don't have the risk of truly blowing up though the balance sheet looked reasonable.  Analyzing a bank's balance sheet more than just the bare minimum basics (in my view) is time that could be used analyzing something more tangible.  For example, just wait for a community bank to fall to 50% of TBV and buy -- no analyzing need -- in the Benjamin Graham spirt.

 

Cheers

JEast

 

Fair points.  I would agree that the very large banks aren't really suitable to be analyzed in the same way that a smaller bank is.  For me, that's why an investment in them (which I do own) would be sized accordingly. 

 

But I think a lot of the concern about bank's balance sheets, especially smaller banks, is misplaced (not saying by you, just in general).  Sure, we can't analyze their loans and even if we could it wouldn't really be practical to look at hundreds of loans in depth prior to making an investment.  Even if we had access, it would take too long and take too many resources.  But I would say that any insurance company that is capable of being taken down by a catastrophe or a retailer that is capable of being taken down by changes in fashion aren't in so different a position really. 

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This is a point I never understand, at least as it relates to community banks.  A community bank has 2 basic assets - loans and securities.  It has one main liability - deposits.  No, we can't see any of these and examine them so we essentially need to assume that the values being placed on them by management are correct or haircut them in some generic way we find appropriate.  But how is this different than really any company?  Is FFH not a black box?  BRK?  Why is an insurance company not a black box?  Seems kind of the same at a macro level to me.

 

Kraven,

here is what I wrote to Christopher1 just yesterday:

 

Have you ever made a comparison between BNP Paribas (or any other large bank) and Fairfax? BNP Paribas has a ratio total assets vs. tangible equity of 26, for Fairfax that ratio is 3.4. It means that BNP Paribas has put to risk $26 for each $1 it owns, while Fairfax has put to risk $3.4 for each $1 it owns. Moreover Fairfax has put those $3.4 to risk through HWIC, which is a very small corporation, and therefore very easy to manage and control. Doesn’t it strike you as a comparison between two utterly different risk profiles?

I also tend to compare the equity of an insurance company to the equity of a bank corporation, the float of an insurance company to the deposits of a bank corporation (though their costs are demonstrably different), and the debt of an insurance company to the debt of a bank corporation. And that is because both float and deposits are liabilities whose risk profile is much safer than long-term debt. Now, please consider, for Fairfax total assets are funded this way: 29.3% equity, 60.8% float, 9.9% debt. Instead, for BNP Paribas total assets are funded this way: 3.8% equity, 29% deposits, 67.2% debt.

 

If Fairfax and BNP Paribas are both black boxes, they certainly are two very different black boxes! :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

Gio, your points are well taken, but it's a bit of a strawman argument.  BNP is a weaker bank, so you've compared two things are extremes.  I could say look at VERF compared to FFH.  VERF is a tiny community bank with about $4 of tangible assets for each dollar of tangible equity.  It is almost completely funded with deposits and only $5 mil in debt.  Of course it's impossible to buy.

 

I am not saying banks and insurance companies or FFH, in particular, are identical investments.  But my point stands.  If a bank is a black box, so is an insurance company.  It doesn't matter to me that one might be more leveraged than another.  Balance a bowling ball on a pin and some level it doesn't matter how thick that pin is (unless it is not really a pin at all but something else with a point on the end).

 

So BNP and FFH may be different kinds of black boxes, but at the end of the day one still has to rely on the numbers as they stated in the financials.  Nothing more or less.

 

I agree.

Still I believe simple heuristics like “skin in the game” and “small is beautiful” (because small is easy to manage and therefore to control) go a long way in business.

Then, hey!, I have learnt: “you don’t know what you cannot know”, right?  ;)

 

Cheers!

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

 

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This is a point I never understand, at least as it relates to community banks.  A community bank has 2 basic assets - loans and securities.  It has one main liability - deposits.  No, we can't see any of these and examine them so we essentially need to assume that the values being placed on them by management are correct or haircut them in some generic way we find appropriate.  But how is this different than really any company?  Is FFH not a black box?  BRK?  Why is an insurance company not a black box?  Seems kind of the same at a macro level to me.

 

Kraven,

here is what I wrote to Christopher1 just yesterday:

 

Have you ever made a comparison between BNP Paribas (or any other large bank) and Fairfax? BNP Paribas has a ratio total assets vs. tangible equity of 26, for Fairfax that ratio is 3.4. It means that BNP Paribas has put to risk $26 for each $1 it owns, while Fairfax has put to risk $3.4 for each $1 it owns. Moreover Fairfax has put those $3.4 to risk through HWIC, which is a very small corporation, and therefore very easy to manage and control. Doesn’t it strike you as a comparison between two utterly different risk profiles?

I also tend to compare the equity of an insurance company to the equity of a bank corporation, the float of an insurance company to the deposits of a bank corporation (though their costs are demonstrably different), and the debt of an insurance company to the debt of a bank corporation. And that is because both float and deposits are liabilities whose risk profile is much safer than long-term debt. Now, please consider, for Fairfax total assets are funded this way: 29.3% equity, 60.8% float, 9.9% debt. Instead, for BNP Paribas total assets are funded this way: 3.8% equity, 29% deposits, 67.2% debt.

 

If Fairfax and BNP Paribas are both black boxes, they certainly are two very different black boxes! :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

Gio, your points are well taken, but it's a bit of a strawman argument.  BNP is a weaker bank, so you've compared two things are extremes.  I could say look at VERF compared to FFH.  VERF is a tiny community bank with about $4 of tangible assets for each dollar of tangible equity.  It is almost completely funded with deposits and only $5 mil in debt.  Of course it's impossible to buy.

 

I am not saying banks and insurance companies or FFH, in particular, are identical investments.  But my point stands.  If a bank is a black box, so is an insurance company.  It doesn't matter to me that one might be more leveraged than another.  Balance a bowling ball on a pin and some level it doesn't matter how thick that pin is (unless it is not really a pin at all but something else with a point on the end).

 

So BNP and FFH may be different kinds of black boxes, but at the end of the day one still has to rely on the numbers as they stated in the financials.  Nothing more or less.

 

I agree.

Still I believe simple heuristics like “skin in the game” and “small is beautiful” (because small is easy to manage and therefore to control) go a long way in business.

Then, hey!, I have learnt: “you don’t know what you cannot know”, right?  ;)

 

Cheers!

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

At least in the context of banks and insurance companies, I'm not sure I would agree with this. Cost of float is key to the economics of both of these businesses. The smaller the institution, the lower base over which costs can be spread and the higher the cost of float.

 

I spent a fair amount of time looking at community and smaller regional banks, and it seemed many had a very high cost of deposits. With 4.0-4.5%+ cost of deposits and long-term treasuries at 3.1% these banks did not look very attractive to me, even at sizable discounts to book.

 

Would be curious to know how other folks think about this, or about economies of scale generally.

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What are these banks actually paying on deposits?  Maybe I should switch banks

It's not so much the interest expense as the non-interest expenses (e.g., salaries, occupancy etc) being spread over a smaller deposit base that drives the cost so high.

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What are these banks actually paying on deposits?  Maybe I should switch banks

It's not so much the interest expense as the non-interest expenses (e.g., salaries, occupancy etc) being spread over a smaller deposit base that drives the cost so high.

 

I agree. But I was referring to the way the money is first collected and then used. Not to the amount of money. A small, very focused team, led by a very driven individual, is much more effective, imo, than a large and widely scattered organization. In the first case errors can be more easily averted and, when committed, can be more easily identified and dealt with, before they become pernicious.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

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Any books which can help me understand banking industry and how to read and interpret their financial statement?

 

I understand their might not be just one book. Good way would be to understand industry and learn accounting seperately to apply to it. I am looking for more of things to consider or different facets of the business and its balance sheet.

 

Just wanted to hear thoughts about board members as there is lot of discussion about banking sector on this board yet someone like WEB is still able to spot amortization charge on WFC income statement which he claimed no one talks about including analysts.

 

Bank Management - Koch http://www.amazon.com/Bank-Management-Timothy-W-Koch/dp/0324655789

Commercial Banking - Management of Risk http://www.amazon.com/Commercial-Banking-Management-Benton-Gup/dp/0470810726

 

Decent books. Look for others by same authors for additional reading.

 

I would also encourage you to read call reports at the FDIC and instructions. This is very important from a smaller bank research level as there are lots of details embedded in the reports.

 

 

 

 

 

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