Written By: Robert Ashbaugh
Peer analysis is a tool many banks use to provide benchmarks and context for financial results. Selecting that peer group is critical for the peer analysis to be accurate. Too often, banks use peers with whom they compete directly for revenue and do not give regard for the non-revenue parts of the profiles with which they are more closely aligned.
A peer group should include banks that are most like the subject bank. This, however, does not necessarily mean the peers are all similarly sized banks in the same state. There are four factors that should be considered as a whole when selecting a peer group:
- Risk appetite
- Product mix
Consider developing a spreadsheet matrix using the four variables, plus any additional variables that your institution deems pertinent. Each potential peer bank should be designated in its own row below. Using the filter function, a basic peer group can be easily determined.
|Risk Appetite||Concentration 1||Concentration 2||Concentration 3||Loan Size||Region|
The first item a bank should consider is whether a potential peer bank has a similar risk structure, or “appetite.” Risk appetite is something that is set by the board of directors and enacted by senior management. It is also generally well-known by employees. Some banks are known to be aggressive commercial real estate lenders while others are high quality consumer lenders. The risk appetite of larger lenders is typically known by reputation and its media presence. It may be a bit more challenging to locate the risk appetite for smaller banks, especially if they are not in the home region of the subject bank. If you are examining a potential peer candidate, the first place to check is with your own management; maybe they are familiar with the bank. Start with the easiest step first. Next, take a look at the annual report or, if possible, the transcript for earnings calls. These documents, combined with any SEC filings, generally state management’s view on risk at least annually.
Product mix is another critical component of peer selection. Because commercial loans are underwritten and serviced differently from consumer loans, they naturally behave differently. Therefore, it would not be wise to include a bank that had a materially different product mix as a peer, as it would tend to skew any comparative results. Product mix can be easily identified by downloading recent call reports from the FFIEC website or Sageworks Bank Information. While no bank will ever have an exact duplicate peer in terms of product mix, it would be best to look at the two or three largest pools and measure them as a percentage of total loans. A logical peer will have pool percentages that are substantially similar to the primary bank.
Too many times, a bank will select peers of a certain loan or asset size. While this can be useful as one variable, do not be concerned by including banks that are larger, maybe even materially larger. That does not mean that a $500 million bank should select a $100 billion dollar bank as a peer, but it might be ok for that same $500 million bank to select a $1.5 billion bank to include in peer analysis. The bank might be similar in every other way, so it would not be right to eliminate it due to differences in size. Having a bank or two that is larger than the subject bank might add additional context to certain metrics, as well as depict to smaller, growing institutions what their banking model might look like in the future. Peer groups are made up of banks with which the subject bank can be compared, but subject banks may also benefit from including banks that they emulate in their peer groups, even if only for their own reference.
Geography is the final method for selecting a peer group. Many times a peer comes from the subject bank’s market, but that is by no means a requirement. Do not be concerned about selecting a bank from the other side of the state, the next state over, or even a bank with which you do not directly compete. If the bank is similar in almost every way, then include it as a peer. Caution should be taken about selecting peers from outside the larger geographic region, such as the southeast, as factors such as real estate prices and local economic performance can differ materially across geographic regions.
When selecting peers, each bank should be measured using all of the metrics identified above. The ones that best match the target should be selected as a peer. Most banks have between five and eight peers, but it is not uncommon to see as many as twenty. Optimally, the peer selection process should be documented in a bank’s policies and procedures document. It is important to note that the board of directors may advise on a set of peers and even regulators may suggest a set of peers. Take them into consideration when selecting a peer group, but do not be concerned about adding or deleting a peer if the research warrants it. Be prepared to support your findings but do not think all peer groups are perfect. Peers change from time to time due to acquisitions and changes to any of the metrics above. Revisit peer groups periodically to delete any peers that have been acquired or whose metrics have changed materially. Examination of peer groups should be done annually to see if any changes need to be made.
Whether it is for an ALLL comparison or a full peer comparison, peer selection is a critical part of the data analysis process. Properly done, a peer comparison will allow management to properly assess the performance of the bank.