A new approach is needed

methodology

Many of the traditional methods of assessing the strength of banks have recently been proven to be inadequate. Credit-rating agencies rated banks AAA just before they failed. Dexia passed a capital adequacy stress test just three months before it failed. EPS growth, tier one ratios, VaR and RoE and other measures frequently used to value a stock simply do not correlate with share price performance.

More accurate 'rules of thumb'

Senior bankers, fund managers and regulators around the world have helped us to select a new set of criteria that reliably identifies banks with the right attributes to trade at a premium to book value.

We discovered a set of measures that reward deposit-funded, profitable and well-capitalised banks. Lafferty Bank Quality Benchmarking helps to explain why some banks trade on 4x tangible book value and other banks trade on multiples far lower.

  • Retail focus
    We ask: is retail where it belongs — at the beginning?
  • Strategy
    Does the bank articulate a clear and consistent long-term strategy, with specific objectives and a clear plan for how to achieve them? Does it specify what products and services are critical, how they will be delivered and how they will measure success? Is the strategy executed consistently across the organisation? Do banks identify their problems and set out clearly what they will do about them? Is the strategy hard to copy? Do they "walk the talk" and do what they say they will do? Do the official statements match reality?
  • Financial measures
    We value Return on Assets more than Return on Equity, because the latter ratio can be "gamed" — and frequently is. We look at wholesale funding ratios, solvency and liquidity.
  • Customer experience
    Customers' satisfaction with their bank is emerging as a critical differentiator for competitors. We examine whether and how a bank is measuring customer satisfaction — and we look for the target it is aspiring to achieve.
  • Conduct
    Has the bank been censured, fined or forced to pay compensation to customers because of mis-selling?
  • Management
    What are the collective talents, professional education, training and experience of the CEO?

Where do we source the information?

All the information we use in the ratings is publicly available in banks' annual reports. However, we sift through the information with a fine-tooth comb. For example, the annual report is often more revealing about a bank than any other public document.

We look for unusual notes in the accounts. We question whether they actually do what they set out to do. We sense the culture in the bank. Does it have a commitment to performance and accountability? We ask ourselves: do they know what they are doing?

We know that our quality rating won't be good news for all banks, so we recognise that we will need to be able to defend its accuracy and objectivity. We welcome feedback on our benchmarking. We will publish corrections should errors be drawn to our attention.

Quality, Integrity, Innovation

We have been watching and reporting on the strategies and performance of banks worldwide for more than 30 years. Our analysts can "read between the lines" of an annual report based on academic research of the content analysis of what CEOs and chairmen say in the statements. We are prepared to "say it as we see it" and go against the crowd.

We are not under pressure to create trading commissions or investment banking business. We don't have any great attachment to any one criteria for scoring quality — we simply aim to select the criteria that will best capture an accurate measure of the quality of a bank, as well as its inherent integrity, credibility and trustworthiness.

The service is new and innovative — because the existing models are broken.

Key conclusion

Banks that score well in our benchmarking tend to trade at a premium price to their tangible book value — evidence that investors appreciate and will pay for quality. Our benchmarking helps explain what qualities the stock market is rewarding and why.