FOR centuries, Jamaicans have witnessed the inception and development of two leading financial giants in the industry, Scotia Group Jamaica Ltd (SGJ) and National Commercial Bank of Jamaica Ltd (NCBJ). Though the journey has certainly been challenging, both banks are currently engaged in a close race for the title of the biggest and most profitable bank in Jamaica. While the different business models employed by each management team have yielded success for the respective companies, it should be interesting to see which one comes out on top in the local banking industry.

Historically, the designation for the most profitable bank has been claimed by the Canadian subsidiary, SGJ. However, over the past three years NCBJ has been able to narrow the gap to under $1 billion. In terms of capital base, NCBJ is regarded as the largest bank on the island, with total assets averaging $191.05 billion or $3.4 billion more than that of SGJ over the last decade. Likewise, this measure has been converging recently, with NCBJ’s lead reduced to only $459 million in 2009.

Currently, more than halfway into 2010 and with the consequences of the Jamaica Debt Exchange (JDX) Programme well into effect, the bottom line and total asset base for these two leading institutions have been moving closely in line. For its fiscal six-month period, NCBJ reported net profit of $5.33 billion with total assets of $323.3 billion, similar to SGJ’s net profit of $5.38 billion and total assets of $323.76 billion for the same period.

NCBJ has already reported its 9M results on July 22, 2010, with a 10.12 per cent increase in net profit to $8.08 billion, up from $7.34 billion a year ago. However, for the quarter, net profit was relatively flat at $2.76 billion, as net interest income, its biggest revenue driver increased by only 3.2 per cent to $5 billion, a stark reduction compared with an average annual growth rate of 17 per cent seen in the past 3 years. Furthermore, NCBJ’s bottom line relies more on interest income from securities, with approximately 60 per cent of total interest income coming from securities, while SGJ, implementing a more conservative approach makes about 40 per cent of interest income from securities and the remaining 60 per cent from loans — a comparison dictating the fundamental difference between both banks’ business models.

At the same time, it should be noted that given current economic conditions increasing a bank’s loan portfolio also increases the potential risk for loan defaults. SGJ which has the bigger exposure to credit products, reported that its non-performing loans represented 3.99 per cent of total gross loans, up from 3.81 per cent a year ago. Similarly, NCBJ’s non-performing loans totalled $2.9 billion, which represented 3.3 per cent of gross loans compared to 2.6 per cent in the in the prior year. As a result, in order to maintain profit levels, the banks are challenged to consistently enforce strict risk management strategies.

Additionally, as part of SGJ’s and NCBJ’s strategies to bolster interest income by increasing its loan portfolio, they have begun to implement rate reductions. In May 2010, SGJ became the first mover, cutting its base lending rate by more than two hundred basis points to 17.75 per cent, recording a new five year low. Two months later, NCBJ followed suit reducing its base lending rate by three hundred basis points to 17.75 per cent. While cutting rates have become an area of focus, increasing fee income has also come to the forefront. According to NCBJ’s 9M financial statements, net fee and commission income, which contributes 20 per cent to total operating income, rose by 23 per cent to $4.35 billion.

Moreover, in an effort maintain its profit margin, NCBJ has taken decisive action to reduce costs through a series of mechanisms including staff cuts. In March 2010, the bank executed a redundancy exercise which saw under 130 employees become jobless. With the largest staff complement and branch network among financial institutions, NCBJ is focused on consolidating its business units. This resulted in the merging of four units into two and the closure of two branches this year. On the other hand, SGJ has not chosen to go this route seeking to cut its other operating expenses.

Turning to the stocks’ performance, SGJ is currently trading at $21.61, while NCBJ at $18.50. With the recent earnings convergence the expectation would be that the stock prices will follow suit. However, this has not been the case as investors remain cautious about the bank’s ability to replicate its recent profit history. Nonetheless, since the start of the year both stocks have outperformed the JSE Main Index’s 3.32 per cent gain, with NCBJ rising 15.63 per cent, outpacing the 10.42 per cent advance seen by SGJ. Furthermore, at current prices, NCBJ is more attractively priced at 4.15x earnings, compared with a price to earnings ratio of 6.07x by SGJ. Similarly, NCBJ’s price to book value (P/BV) stands at 0.98x, versus a P/BV of 1.36x for SGJ.

With regards to dividend yield, SGJ has historically rewarded shareholders with consistent quarterly dividend payouts, ranking them among the top five dividend yielding stocks on the Jamaica Stock Exchange (JSE) year-over-year. NCBJ is also known for paying dividends, and has recently increased its annual dividend payout. As a result, NCBJ has now become the second highest dividend paying stock on the JSE, with a twelve month trailing dividend yield of 9.19 per cent, compared with a twelve month trailing dividend yield of 8.28 per cent for SGJ.

NCBJ and SGJ continue to dominate the banking industry while other banks have to yet show their commitment to expand and produce long-term shareholder value. However, as the playing field for the two leaders has been levelled, this presents an opportunity for either bank to take the clear lead through product innovation and prudent risk management strategies.

Juvenne Yee is an Equity Trader at Stocks & Securities Ltd. You can contact her at jyee@sslinvest.com.