1. Turning Bank Financial Statements into Useful Ratios & Trends
November 2014
Presented by: Timothy P. Harrington, CPA
T.E.A.M. Resources
7049 Tanque Verde Road, PMB 136
Tucson, AZ 85715

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4. About Timothy Harrington, CPA
26 years Financial Institution experience
34 years business/consulting experience
Consulted on over 1,000 projects
Speaker at over 1,000 events
Faculty of 3 National Financial Schools

5. Balance Sheet
Assets
Earning Assets
Umpqua bank

6. Balance Sheet
Liabilities and Equity (Capital)
Umpqua Bank

7. Income Statement
Revenues and Expenses
Umpqua Bank

9. Earns
Have
Owe
Pays
Own

10. 10

11. ROA and Spread Analysis
(aka: Net Interest Margin Analysis)
Measures: Profitability and how it was attained
Formula: Each of the key balances on the Income Statement is divided by Average Assets (for simplicity, we will use Total Assets in our example instead of Average Assets)
The Spread Analysis is a ratio of key balances on the Income Statement compared to the bank’s Average Total Assets. This allows a comparison between periods and between financial institutions based on their asset size.
Since banks earn most of their revenue from their major, earning assets (Loans and Investments) and one of their highest expenses is often from their major liability (Deposits), measuring the effect of the Income Statement against the size of the Assets makes sense. This is a standard banking measure. 11

12. Profitability How we earn profit How we measure it
Spread Analysis:
Simply dividing the Income Statement amounts by Average Assets

13. Which bank is doing better? Why we use comparable ratios
10 Bil bank Mil bank
Interest income $ 496,000, ,630,000
Cost of funds (175,000,000) (640,000)
Net Interest ,000, ,990,000
Operating costs (Burden) (329,000,000) (3,320,000)
Provision for loan losses (111,000,000) (440,000)
Net loss before other income (120,000,000) ,000
NII – Non-interest income ,000, ,000
Tax Expense (2,000,000) (320,000)
Net Profit or Loss $ 14,000, ,000
Total Equity $ 500,000, $10,000,000 13

14. Which bank is doing better? Spread with ROA (ROAA)
As a % of Average Assets $10 Bil $100 Mil
Yield: Interest income % %
Less: Cost of funds (0.75% ) (0.64%)
Net Interest Margin (NIM-Spread) % %
Less: Non-Interest Exp (Burden) (3.29%) (3.32%)
Less: Provision for loan losses (1.11%) (0.44%)
Net loss before other income (1.20%) %
Plus: NII-Non-interest income % %
Less: Tax Expense (0.02%) (0.32%)
Equals: Return on Assets (ROA) % %
Equity Ratio % % 14

15. The ‘Banking’ Business
Banks make money 2 ways:
Interest Income
Non-Interest Income (Other Income)
Banks spend money 4 ways:
Cost of Funds, Deposits and Borrowings
Non-Interest Expenses (cost of people, buildings, and systems)
Provision for Loan Losses (cost of building the Allowance for Loan Losses)
Taxes

16. Spread Commercial Banks $1 Bil to $100 Mil
As a % of Average Assets /30/ /31/97
Yield: Interest income %
Less: Cost of funds (0.48%) (3.70)
Net Interest Margin %
Less: Non-interest expense (3.05%) (3.56)
Less: Provision for loan losses (0.12%) (0.29)
Net loss before other income %
Plus: Non-interest income % Less: Taxes (0.23%) (0.64)
Equals: Net Profit or Loss (ROA) %

17. Source: FDIC
Umpqua Bank

18. Net Interest Margin: All US Banks
Umpqua Bank

19. Source: FDIC
Umpqua Bank 19

20. ROA: All US Banks
Umpqua Bank

21. Umpqua Bank

22. Let’s Calculate Spread
Comparative Balance Sheets (2 years)
We will use this to prepare a Spread Analysis for SAMPLE BANK.
Umpqua bank

23. Spread Analysis or Net Interest Margin
1. Calculate Average Assets
Total Assets Beginning of Year + Total Assets End of Period / 2
$11,795,443 + $11,636,112 / 2 = $11,715,778
There are other ways to calculate Average Assets, but this is a simple, common way of doing so 23

24. Income Statement for 12/31/13 Only
We will use this to prepare a Spread Analysis for SAMPLE BANK.
Income and expenses must be ANNUALIZED.
This ratio works when the Income Statement is for 12 months. If the Income Statement is for less than 12 months, you must annualize the income.
e.g. To Annualize income, divide by the month number (from September, divide by 9: ninth month) and multiply by 12 (months) 24

25. Spread Analysis or Net Interest Margin
2. Yield on Assets (Yield)
Interest Income from loans and investments / Average assets
$442,846 / $11,715,778 x 100 = 3.78%
3. Cost of Funds (COF)
Dividends paid / Average assets
$37,881 / $11,715,778 x = 0.32%
Subtract COF from Yield and you get
4. Net Interest Margin (NIM) = 3.46% =

26. Spread Analysis or Net Interest Margin
5. Non-Interest Expense Ratio
Total non-interest expenses (excluding Provision for Loan & Lease Losses) / Average assets
$355,825 / $11,715, = 3.04%
6. Provision for Loan and Lease Losses Ratio
PLLL / Average assets
$10,716 / $11,715, = 0.09% 26

27. Spread Analysis or Net Interest Margin
7. Non-Interest Income (NII) Ratio (OI-Other Income) (Service Revenues, Fees, Commissions, etc.)
Total NII / Average assets
$112,605 / $11,715,778 x = 0.96%
8. Tax Expense Ratio
Total Expense / Average assets
$52,668 / $11,715,778 x = 0.45% 27

28. Spread Analysis or Net Interest Margin
9. Return on Average Assets (ROA)
Net income / Average assets
$97,573 / $11,715,778 x = 0.83%
(there will often be a 1 or 2 basis point difference between added ROA and Calculated ROA)
This number is also the sum of the items above it in the spread analysis: Yield – Cost of Funds + Non-interest Income – Non-Interest Expenses – Provision for Loan Losses = Return on Assets 28

29. Spread for Sample Bank As a % of Average Assets Sample Bank
Yield on Assets
Cost of Funds (0.32)
Net Interest Margin (Spread)
Non-Interest Expense (3.04)
Provision for loan losses (0.09)
Non-Interest Income (Other Income)
Tax Expense (0.45)
ROA: Net Profit or Loss

30. Umpqua Bank

31. Capital is Important to:
Provides a cushion
For unexpected losses
Provides Stability
The company’s ‘keel’
Allows bank to take calculated risks
Allows bank to sustain growth in assets
Ensures general public of safety and soundness of institution 31

32. What is Capital? Capital is not cash
It is the accumulated earnings and losses since the bank was established.
Tells you what portion of your assets belong to the owners, meaning the rest is dedicated to your creditors
Your ‘rainy day’ fund
Your ‘hibernation’ fat

33. 33

34. Common Capital Accounts
Stock (at par value)
Preferred
Common
Surplus (in excess of par)
Undivided Profits … retained earnings
Increases with Annual Net Profit
Decreases with Annual Net Loss
Net Unrealized Gains (Losses) on Available-for-sale (AFS) Securities

35. Capital Ratios
Measures stability of the bank and ability to sustain growth
Total
Assets
Core Capital = 10.77%

36. Capital Ratios
If Assets grow, and Capital doesn’t grow proportionately, the Ratios will decline
Total
Assets
Woops! Now 8.60%

37. If Assets grow and capital doesn’t keep up, the bank becomes unstable

38. Negative economic change …Large Charge-offs… Your sail boat could tip
If a Big Wind comes up…
Negative economic change
…Large Charge-offs…
Your sail boat could tip
Bank needs more Capital

39. All US Banks Source: FDIC
Umpqua Bank

40. How much capital is enough?
Project worst 3 years possible (this is what ALM is all about)
Prompt Regulatory Action Rules
National or Peer Averages
Depends on how much risk your assets and liabilities represent
Depends on level of growth
Depends on level of profitability
Depends on future plans

41. Capital Can Disappear Fast
Arizona Federal

42. Prompt Corrective Action

43. Prompt Corrective Action
Adequately capitalized institutions
Such institutions must receive a waiver from the FDIC to accept, renew or roll over brokered deposits (banks sell these large-denomination deposits to brokerages). A waiver is granted on a case-by-case basis, upon a finding that acceptance of such deposits does not constitute an unsafe and unsound practice.
If granted, an institution may not pay an effective yield that exceeds by more than 75 basis points the effective yield paid on deposits of comparable size and maturity.
Institutions that are undercapitalized to varying degrees must take additional actions and have additional requirements:

44. Prompt Corrective Action
Undercapitalized institutions
-must file an acceptable capital restoration plan;
-cannot pay dividends or management fees;
-may not accept, renew or roll over any brokered deposit; and
-may not solicit any other deposits by offering an effective yield that exceeds by more than 75 basis points the effective yield paid on deposits of comparable size and maturity.
Significantly undercapitalized institutions
-are subject to the same actions as an undercapitalized bank;
-cannot pay bonuses to, or increase compensation of, senior executive officers without prior regulator approval; and
-are subject to other restrictions and actions as noted in the Federal Deposit Insurance Corporation Improvement Act (FDICIA).

45. Prompt Corrective Action
Critically undercapitalized institutions
-are subject to the same provisions as an undercapitalized bank and a significantly undercapitalized bank; and
-cannot pay interest or principal on subordinated debt (without FDIC waiver) after 60 days of becoming critically undercapitalized.
In addition, within 90 days of the bank becoming critically undercapitalized the chartering authority must:
-appoint a receiver; or
-take other such actions that the primary regulator, with the concurrence of the FDIC, determines would better serve the purposes of prompt corrective action (and review such determination every 90 days).

46. Regulatory Capital
Leverage Capital The minimum leverage ratio requirement consists only of Tier 1 (Core) Capital.
Tier 1 Capital or Core Capital is the sum of:
common stockholders' equity – the sum of common stock and related surplus, undivided profits, disclosed capital reserves that represent a segregation of undivided profits, and foreign currency translation adjustments, less net unrealized losses on available-for-sale equity securities with readily determinable fair values;
noncumulative perpetual preferred stock
minority interests in consolidated subsidiaries minus
all intangible assets other than …
See Handout on Capital

47. Regulatory Capital Tier 1 Capital is calculated as follows:
+ Permanent shareholders’ equity
+ Undivided Profits (retained earnings)
Less: Goodwill
Tier 2 Capital is calculated as follows:
+ General provisions/general loan-loss reserves
+ Revaluation reserves
+ Hybrid (debt/equity) capital instruments
+ Subordinated term debt
Less: Investments in unconsolidated financial subsidiaries
Less: Investments in the capital of other financial institutions
Total Capital = Tier 1 Capital + Tier 2 Capital

48. Regulatory Capital
Tier 1 Risk-Based Capital: Tier 1 Capital / Risk Weighted Assets
Tier 2 Risk-Based Capital: Tier 2 Capital / RWA
Total Risk-Based Capital: Tier 1 plus Tier 2 Capital / RWA
Leverage Ratio: Tier 1 Capital / Total Assets – goodwill, other disallowed intangible assets and disallowed deferred tax assets
You have been provided a Regulatory Capital Estimation Tool as developed by FDIC

49. ROE – Return on Equity Measures: Return to Investors
Formula: Net Income divided by Shareholder Equity 49

50. Source: FDIC
Umpqua Bank

51. ROE: All US Banks
Umpqua Bank
51/69

52. Sources of Non-Interest Income
Deposit service charges
Fiduciary activities
Trading revenue
Investment, advisory and brokerage
Insurance commission fees and income
Servicing fees
Net gains (losses) on sales of loans
Other net gains of (losses)

53. Spread Commercial Banks $1 Bil to $100 Mil
As a % of Average Assets /30/ /31/97
Yield: Interest income %
Less: Cost of funds (0.48%) (3.70)
Net Interest Margin %
Less: Non-interest expense (3.05%) (3.56)
Less: Provision for loan losses (0.12%) (0.29)
Net loss before other income (0.56%)
Plus: Non-interest income % Less: Taxes % (0.64)
Equals: Net Profit or Loss (ROA) %

54. Umpqua Bank
54/69

55. Efficiency Ratio
Measures: Percentage of Controllable Income that is used up by Operations OR “How much does it cost for you to earn $1 in Net Revenue”
Formula: Operating Costs – Amortization of Intangible Assets  [Interest Income – Cost of Funds + Non-interest Income]
Industry Standard: Bank averages range between 55% and 70% depending on size and business model
How to Improve:
Increase Interest Income
Decrease Cost of Funds
Increase Non-interest Income
Decrease Operating Costs
Typically, the lower this ratio is, the better. This means your cost per dollar earned is less 55

56. Efficiency Ratio Operating Expenses – Amort of Intang Asts
Interest Income - COF + Non-Interest Income
$355,825 - $4,781
($442,846 - $37,881 + $108,915)
$351,044 X = 68.31%
$513,880

57. Umpqua Bank

58. Non-Performing Loans Ratio
Measures: Quality of Loan Portfolio based on what percentage is currently late by 90 days or more
Formula: Dollar Amount of Delinquent Loans (90+days)  Total Loans
Industry Standard: Somewhere in the 0.50% to 1.50% range, depending on strategy. Banks that take more credit risk will have higher ratios. 58

59. Net Charge-offs
Measures: Quality of Loan Portfolio based on the percentage of loans removed from the books (so far this year) as non-performing.
Formula: [Charge offs – Recoveries]  Average Loans (Charge-offs and Recoveries must be annualized)
Industry Standard: Somewhere in the 0.25% to 0.75% range, depending on strategy.

60. Non-Performing Loans and Charge-offs
$100 mil to $1 Bil Asset Category
Normal 6/30/14
Delinquency % 1.59%
Charge-offs % 0.21%
Combined % 1.80%

61. Umpqua Bank

62. Loan to Assets Ratio Measures: Percentage of Assets funded by Deposits
Formula: Total Loans  Total Assets
Industry Standard: 50% to 65%
Generally, the higher the ratio the better. However, ratios getting too high can create liquidity problems. 62

63. Thank You! Timothy Harrington, CPA T.E.A.M. Resources
7049 East Tanque Verde, PMB 136
Tucson, AZ 85715
(800) 63