Bank Stock Prices

1. Bank Stock Prices Discussion by: Philip E. Strahan Boston College September 2006

2. Research Questions • Furlong & Kwan: What drives the level of bank stock prices (market-to-book)? • Schuermann & Stiroh: What drives variation in bank stock prices?

3. What is correlated with the level of bank stock prices? • Market trends • Bank MTB rose in the 1990s • Bank characteristics • Core deposits (++) • Efficiency = Revenues / Expenses (++) • Non-interest income share (++, large banks) • Loan shares (??) • Log of assets (??)

4. Strong claims • “rebound in bank charter values suggests that … banks remain special” • “negative effect of size on relative charter value…would be consistent with policy measures having reduced market’s expectations for TBTF rescues…” • “provision of core deposit services contributes to charter value ratios…” • “the market apparently has seen the reliance on fee-based activities as a positive development”

5. How do you interpret these regression? • Bank size and stock prices (CV) • TBTF banks will have high stock prices • Large banks may be more or less efficient • High CV banks will grow • High CV banks will buy low CV banks • High CV (e.g. Tobin’s Q > 1) will lead to capacity expansion in the industry

6. How do you interpret these regression? • Lending activity & stock prices • Are C&I loan markets competitive • Or, do banks with high CV avoid risky business loans? • Non-interest income share • Levels (MTB) v. returns • Efficiency (revenue per $ of expenses) • What makes banks have efficient?

7. Suggestions for Furlong & Kwan • Soft-pedal some claims • Paper has no identification strategy to sort our casuality • Decompose results into cross-sectional and time-series dimensions • Between v. firm fixed effects results • Report / discuss sample properties – e.g. how do you handle M&A? • Cluster residuals at bank-level for more conservative statistical tests

8. What is correlated with variation in bank stock prices? • Market factor dominates • Residual correlation remains, even with 9-factor model • Bank returns more correlated to market than other firms • Large bank betas >> small bank betas • Residual correlation for large banks >> for small

9. Questions • What is the role of credit, interest rate and liquidity risks? • Less true for small banks • Estimate models with just credit, interest rate and liquidity factors • Is residual cross-bank correlation large or small?

10. Suggestions for Schuermann & Stiroh • Focus on issue of systemic risk • What happens to factor loadings during ‘events’? • What happens to residual correlation across banks during events? • Why are large bank returns so much more systematic? • Incentives (exploit variation in TBTF over time) • Clients (large v. small borrowers) • Product difference (derivatives; off-balance sheet commitments; loan portfolios)

11. Is MTB ratio (still) correlated with stock-market variation? • Systematic (beta) • Idiosyncratic • Residual correlation (or, loading on bank-factor)