From Stress Testing to M&A, Financial Innovator Revamps Analytics

By Lisa Getter

When bank regulators referred to FreeCapital™ at a bank conference earlier this year, no one in the audience was confused. That’s because Invictus Consulting Group, which introduced the metric, has been at the forefront of bank analytics that have changed the very lexicon of community banking.

These new metrics are necessary to facilitate any meaningful analysis for community banks that are undertaking strategic planning or mergers and acquisitions. The recession led to economic changes and a radical new approach to regulatory capital calculations that rendered traditional analytical techniques invalid. Here’s a glimpse at the Invictus glossary:

• FreeCapital is the difference between the bank’s actual capital and its regulatory mandated capital. It is the capital that is available to bank management for the implementation of all strategic and capital actions and can be calculated only through stress testing. Community banks can use stress testing to prove to regulators that they can operate with a lower regulatory capital requirement than the regulator might otherwise impose. This increases the bank’s FreeCapital, which, when effectively deployed, can make a dramatic improvement to the bank’s ROI.
• LoanLayering uses an Invictus proprietary algorithm to redefine loan balances and balance projections, taking into consideration vintage and maturity schedules. It overcomes the limitations and misleading conclusions that arise from the traditional static analysis of a bank’s current outstanding balances. It has a profound impact on the calculation of regulatory capital requirements and future profitability by bringing into consideration loan vintage, pricing and the inherent repayment schedules that define the pro forma performance of loan portfolios.
• LoanDecay and portfolio HalfLife represent an extension of the LoanLayering approach. They replace static balance sheet and P&L analysis in the creation of bank strategic plans and the analysis of potential bank acquisitions. LoanDecay is a highly quantified metric that provides a key basis for analytics. HalfLife is a valuable comparative ratio that summarizes the effective duration of different portfolios.
• IncomeDecay takes into consideration LoanDecay and incorporates the impact of loan vintage and the relevant interest rates to measure the pro forma earnings contributions of specific portfolios and their sensitivity to changing rates and yield curves.
• Invictus Return on Required Capital Ratio is a ratio that supersedes the faulty Return on Assets ratio, which gives an incomplete assessment in today’s regulatory environment. That’s because different asset categories carry different risk profiles and unique regulatory capital requirements, which contribute to a bank’s total regulatory capital obligation. Given the traditional risk/reward nature of different loan categories, high return portfolios tend to carry higher capital requirements. Banks with high return and high risk portfolios will naturally have higher ROA ratios but, very possibly, low returns on the capital required support these high risk assets. The Invictus Return on Required Capital Ratio puts the necessary focus on the return on capital associated with different loan portfolios.

The InvictusRatio is more meaningful in an M&A landscape since buyers can re-engineer a seller’s liability structure, cost structure, and fee income capabilities.

“Invictus will have a dramatic effect in the future on the analytics of bank M&A,” says banking attorney James R. Hannon , of Gozdecki, Del Giudice, Americus, Farkas & Brocato LLP in Chicago. “Based on the targeted bank’s loan portfolio, Invictus can now provide an invaluable tool to the acquiring institution to gauge the consequences to regulatory capital on the merged entity. Invictus has added a whole new dimension to the due diligence process in bank M&A,” he said.

Boston bank attorney Stanley V. Ragalevsky of K&L Gates agreed. “It is important for bank boards and management to analyze performance using metrics that tie capital and asset composition together in order to get a more a complete picture of risk adjusted returns. This can be crucial in evaluating merger opportunities and other strategic transactions as it seems to be the best way to estimate the overall accretive or dilutive effect a transaction will have on capital over time,” he said.