Financial Analysis ofDepository Institutions

Finance 129Drake University

Basic Financial Statements

Report of ConditionBalance Sheet

Report of IncomeIncome Statement

Funds Flow StatementSources and Uses of Funds

Statement of Stockholders Equity

Balance Sheet

Financial Outputs(uses of Bank Funds or Assets)

Cash (primary reserves)Liquid Security Holdings

(secondary Reserves)Investments in SecuritiesLoans

ConsumerReal EstateAgFin InstitutionsMics Loans

Misc

Financial Inputs(Sources of Funds or

Liabilities and Owners Equity)Deposits from Public

DemandNOW’sMoney marketsSavingsTime

Nondeposit BorrowingsEquity Capital

StockSurplusRetained EarningsCapital reserves

Balance Sheet continued

As with any balance sheetAssets = Liabilities + Owners Equity

orAccumulated uses Accumulated

sourcesof bank funds of bank funds

=

Balance Sheet Components Assets

The Cash Accountincludes: Cash in the vault, deposits with other banks, cash items in the process of collection and reserve accounts with the Federal ReserveTraditionally banks attempt to keep this account as low as possiblePrimary reserves since it is banks first line of defense against withdraws Generate little income

Balance Sheet Components Assets

Investment Securities: The Liquid PortionQuickly converted into cashSecondary reserves

Investment Securities: Income Generating Portion

Taxable and nontaxableCan be recorded at original cost or market value or the lower of the twoMore important recently

Balance Sheet Components Assets

LoansLargest AssetGenerally broken down by purpose of loans –

Different risk (& return) and liquidity of each loan typeChoice of loan type impacts interest income

Gross loans -- total of all outstandingAllowance for Loan losses (ALL account)

PLL on income statementGross minus ALL = Net Loans

Balance Sheet Components Assets

ALL accountoften divided into two sections, specific reserves, and general reservesTax reform Act of 1986

only loans actually declared uncollectable can be expensed through the ALL accountsdecreased use of ALL accountsPermanent capital

Balance Sheet Components Assets

Federal Funds Sold Securities Purchased under Resale AgreementsCustomers liability AcceptancesMisc Assets

Balance Sheet Components Liabilities

Deposits (Impacts Interest expense)Noninterest bearingSavingsNOW accountsMoney Market AccountsTime Deposits

Borrowings from Nondeposit sources (Int Exp)Capital Accounts

Book vs. “Fair Value”

Banks have traditionally recorded balance sheet entries at original cost (book value or historical cost accounting -- ammoritzed cost)Implies that interest rate fluctuations would not impact valuesFair Value -- current market value

Arguments against Fair Value

Increased in the volatility of earningsGreater instability in stock prices of banksLoss of bank capital cushionsLack of resale market

Income Statement or Report of Income

Revenue ItemsInterest Income (interest generated from loans normally accounts for most income -- generally more than 2/3 of total income)Non interest income (fee income, etc.) Increasingly important. Non interest income also includes securities gains (or losses). Now subject to standard tax rate

Report of IncomeExpenses

Interest Expenselargest expense is interest paid on deposits, often between 50 and 60% of total expensesVaries based on type of depositsfed funds borrowing and repurchase agreements have grown in importance.

Non interest expensewages, salaries and other personnel expenses+

Income

Net Interest Income = Total Interest Income -Total Interest ExpenseAlso referred to as interest margin

Net incomeAdds non interest income and subtracts non interest expense to net interest income.

Income Statement

Interest IncomeInterest on loans, Interest on securities, Other

Interest ExpenseDeposit Interest, Short term debt, Long Term debt

Net Interest IncomeNon interest Income

Service Charges, Trust Department, OtherNon interest Expense

Wages, Net occupancy, Other operating expensesIncome before taxesProvision for income taxes

Net income after taxes

Funds - Flow Statement

Funds from operations+ decreases in bank assets+ increases in bank liabilitiesFunds provided to the bank

Dividends paid out to stockholders

+ increase in banks assets+ decreases in bank

liabilitiesFunds Used by the bank

=

Capital Account Statement

Beginning Balance + Net income - Dividends paid to shareholders+ New Shares of Stock issued - Purchases of treasury stockBalance at end of period

Common Characteristics of Banks Financial Statements

Heavy dependence on borrowed fundsEarnings are exposed to risk if borrowings cannot be repaid

Growing use of nondeposit borrowingsBank must hold a significant proportion of high quality and marketable securities

Financial Assets are more important than plants and equipment

few fixed costs and limited use of operating leverage.

Evaluating and Measuring Bank Performance

Going to use ratio analysis to evaluate the performance of depository institutionsBank data is available in the call reports and via the Uniform Bank Performance Report (UBPR).

Obtaining Information on Banks

Data for banks is available from the Uniform Bank Performance Report (UBPR).UBPR developed by the Fed, FDIC, and office of the comptroller of Currency so that there would be a standardized way to compare institutions.Also peer group and state reports for comparable banks.

UBPR

Goal is to provide uniform reporting of informationDeveloped by the Federal Financial Institutions Examination Council’s quarterly reports.Available online at www.FFIEC.org

Using the UBPR

Compare across yearseach report has 5 years of dataYear end or current quarter plus 1 year prior to current and three previous years

Compare to peer groupsalso available are peer groups reports based on both size of bank and geographic locationAllows you to benchmark

ROE and ROA

ROE measure the rate of return flowing to the banks shareholders

ROA measures managerial efficiency -- how well management converts assets into net earnings. The UBPR uses average assets instead of total assets.

CapitalEquity Totalsafter taxe incomeNet ROE

Assets Totalsafter taxe incomeNet ROA

Relationship between ROE and ROA

Assets TotalAssets Total

Equity TotalIncomeNet ROE

MultiplierEquity ROAEquity TotalAssets Total

Assets TotalIncomeNet ROE

DuPont Identity

Equity TotalAssetsROA ROE

Assets TotalIncome Total

Income TotalIncomeNet

Assets TotalIncomeNet ROA x

nUtilizatioAsset

x MarginProfit

ROA

Decomposition

MultiplierEquity

onUtilitzatiAsset

MarginProfit

ROE

MultiplierEquity ROAROE

nUtilizatioAsset

x marginProfit

ROA

Decomposition

Equity MultiplierReflects the leverage or financing policies (the choice of debt or equity)

Profit MarginReflects the effectiveness of expense management control

Asset utilizationReflects the ability to manage the mix and yield on the banks assets

Asset Utilization and Profit Margin

Both reflect Management decisions regarding:

Mix of funds raised and investedSize of Bankcontrol of operating ExpensesPricing of ServicesMinimization of tax liability

Asset Utilization

Assets TotalIncomeInterest Non IncomeInterest

Assets TotalIncome Total

nUtilizatioAsset

Assets Earningof Volume

AssetEach

ofn Compositio

AssetEachon Yield

Assets TotalAssets Earning

Assets TotalAssetEach of $

Assets Total

Asseteach on EarnedInterest

IncomeInterest

Asset Utilization

Assets TotalIncomeInterest Non IncomeInterest

Assets TotalIncome Total

nUtilizatioAsset

Assets TotalInc NonInterst

Other

Assets Total

RevenueTrading

Assets TotalFees amdCharges Service

Assets Total

IncomeFudiciary

IncomeInterest Non

Profit Margin

IncomeTotalTaxes

Income

IncomeTotal

ExpensetNonInteres

IncomeTotal

LoanLossesforProvision

IncomeTotal

ExpenseInterest

Income TotalIncomeNet

MarginProfit

Decomposition of ROA

AssetsTotal

Losses LoanFor Provisons

AssetsTotal

ExpenseInterestNon

AssetsTotal

ExpenseInterest

IncomeTotal

ExpensesTotal

RatioExpense

Assets TotalTaxes

IncomeExpenses

TotalRevenue

Total

Assets TotalIncomeNet ROA

Decomposition of ROA Part 2

Assets TotalIncome

SpecialNet Expense

InterestNon Income

InterestNon ExpenseInterest

IncomeInterest

AssetsTotal

IncomeNet

Assets TotalTaxes

IncomeExpenses

TotalRevenue

Total

Assets TotalIncomeNet ROA

Decomposition of ROA Part 2

Assets TotalIncome

SpecialNet Expense

InterestNon Income

InterestNon ExpenseInterest

IncomeInterest

AssetsTotal

IncomeNet

Assets TotalExpense

InterestNon Income

InterestNon

margintNoninteres

Assets TotalExpenseInterest

IncomeInterest

MarginInterest

Net

Other Important Ratios

assets Earningincomeinterest Net

MarginInterestNet

Assets BearingInterest ExpenseInterest

Assets EarningIncomeInterest Spread

Assets Total AverageIncomet Noninteres - Expenset Noninteres

RatioBurden

Incomet Noninteres Incomeinterest Net Expenset Noninteres

RatioEfficiency

Harris National

Net Income / Average AssetsLarge declineBetter relative to industry

Decomposition: Intrust Bank

MultiplierEquity

onUtilitzatiAsset

MarginProfit

ROE

Intrust Bank12/31/2011 12/31/2012 12/31/2011 12/31/2012

Net Income 43,341 33,982 ROE 0.1217 0.1003Total Income 190,346 189,667 Profit Margin 0.2277 0.1792Total Assets 4,065,989 3,705,025 Asset Utliization 0.0468 0.0512total Equity 355,988 338,940 Equioty Multiplier 11.4217 10.9312

Using the UBPR Intrust BankPage 1

Improvement in ROE, but decrease in ROADecrease in Int Income – Low Relative to IndustryHigh real to peers in Non Int Income and Non Int Exp

Assets TotalIncome

SpecialNet Expense

InterestNon Income

InterestNon ExpenseInterest

IncomeInterest

AssetsTotal

IncomeNet

Questions: Intrust Bank

Does well in Net Income – how is there business model different than a traditional bank? How does it generate income – how well does it manage expense?Does the loan mix used by Intrust add risk?