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

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Presentation on theme: "Turning Bank Financial Statements into Useful Ratios & Trends November 2014 Presented by: Timothy P. Harrington, CPA T.E.A.M. Resources 7049 Tanque Verde."— Presentation transcript:

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

2 2 Disclaimer This presentation is designed to provide accurate and authoritative information in regard to the subject matter covered. The handouts, visuals, and verbal information provided are current as of the webinar date. However, due to an evolving regulatory environment, Financial Education & Development, Inc. does not guarantee that this is the most-current information on this subject after that time. Webinar content is provided with the understanding that the publisher is not rendering legal, accounting, or other professional services. Before relying on the material in any important matter, users should carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice. The content does not necessarily reflect the views of the publisher or indicate a commitment to a particular course of action. Links to other websites are inserted for convenience and do not constitute endorsement of material at those sites, or any associated organization, product, or service.

3 3 Sponsors Alabama Bankers Association Arkansas Community Bankers California Independent Bankers Independent Bankers of Colorado Florida Bankers Association Community Bankers Association of Georgia Community Banker Association of Illinois Indiana Bankers Association Community Bankers of Iowa Community Bankers Association of Kansas Kentucky Bankers Association Maine Bankers Association Community Bankers of Michigan Independent Community Bankers of Minnesota Missouri Independent Bankers Association Montana Independent Bankers Association Nebraska Independent Community Bankers Independent Comm. Bankers Assoc. of New Mexico Independent Comm. Bankers Assoc. of NY State Independent Community Banks of North Dakota Community Bankers Association of Ohio Community Bankers Association of Oklahoma Pennsylvania Association of Comm. Bankers Independent Comm. Bankers of South Dakota Tennessee Bankers Association Independent Bankers Association of Texas Vermont Bankers Association Virginia Association of Community Banks Community Bankers of Washington Community Bankers of West Virginia Community Bankers of Wisconsin Directed by The Community Bankers Webinar Network

4 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 About Timothy Harrington, CPA 4

5 Balance Sheet Assets Earning Assets 5

6 Balance Sheet Liabilities and Equity (Capital) 6

7 Income Statement Revenues and Expenses 7

8 8

9 HaveOwe Own Earns Pays 9

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 12

13 Which bank is doing better? Why we use comparable ratios 10 Bil bank 100 Mil bank Interest income $ 496,000,000 4,630,000 Cost of funds (175,000,000) (640,000) Net Interest 321,000,000 3,990,000 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) 230,000 NII – Non-interest income 136,000, ,000 Tax Expense (2,000,000) (320,000) Net Profit or Loss $ 14,000, ,000 Total Equity $ 500,000,000 $10,000,000 13

14 As a % of Average Assets $10 Bil $100 Mil Yield: Interest income 3.96% 4.63% Less: Cost of funds (0.75% ) (0.64%) Net Interest Margin (NIM-Spread) 3.21% 3.99% 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%) 0.23% Plus:NII-Non-interest income 1.36% 0.78% Less: Tax Expense (0.02%) (0.32%) Equals: Return on Assets (ROA) 0.14% 0.69% Equity Ratio 5.00% 10.00% Which bank is doing better? Spread with ROA (ROAA) 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 15

16 As a % of Average Assets 6/30/14 12/31/97 Yield: Interest income 4.21% 8.39 Less: Cost of funds (0.48%) (3.70) Net Interest Margin 3.73% 4.69 Less: Non-interest expense (3.05%) (3.56) Less: Provision for loan losses (0.12%) (0.29) Net loss before other income 0.56% 0.84 Plus: Non-interest income 0.66% 1.13 Less: Taxes (0.23%) (0.64) Equals: Net Profit or Loss (ROA) 0.99% 1.33 Spread Commercial Banks $1 Bil to $100 Mil 16

17 Source: FDIC 17

18 Net Interest Margin: All US Banks 18

19 19 Source: FDIC

20 ROA: All US Banks 20

21 21

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

23 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 Spread Analysis or Net Interest Margin 23

24 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)

25 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 100 = 0.32% Subtract COF from Yield and you get 4. Net Interest Margin (NIM)= 3.46% Spread Analysis or Net Interest Margin = 25

26 5. Non-Interest Expense Ratio Total non-interest expenses (excluding Provision for Loan & Lease Losses) / Average assets $355,825 / $11,715,778 = 3.04% 6. Provision for Loan and Lease Losses Ratio PLLL / Average assets $10,716 / $11,715,778 = 0.09% Spread Analysis or Net Interest Margin 26

27 7. Non-Interest Income (NII) Ratio (OI-Other Income) (Service Revenues, Fees, Commissions, etc.) Total NII / Average assets $112,605 / $11,715,778 x 100 = 0.96% 8. Tax Expense Ratio Total Expense / Average assets $52,668 / $11,715,778 x 100 = 0.45% Spread Analysis or Net Interest Margin 27

28 9. Return on Average Assets (ROA) Net income / Average assets $97,573 / $11,715,778 x 100 = 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 Spread Analysis or Net Interest Margin 28

29 Spread for Sample Bank As a % of Average Assets Sample Bank Yield on Assets 3.78 Cost of Funds (0.32) Net Interest Margin (Spread) 3.46 Non-Interest Expense (3.04) Provision for loan losses (0.09) Non-Interest Income (Other Income) 0.96 Tax Expense (0.45) ROA: Net Profit or Loss

30 30

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 32

33

34 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 Common Capital Accounts 34

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

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

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

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

39 All US Banks Source: FDIC 39

40 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 How much capital is enough? 40

41 Capital Can Disappear Fast 41

42 Prompt Corrective Action 42

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: 43

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). 44

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). 45

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 46

47 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 Regulatory Capital 47

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 48

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

50 Source: FDIC 50

51 51 /6 9 ROE: All US Banks 51

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) 52

53 As a % of Average Assets 6/30/14 12/31/97 Yield: Interest income 4.21% 8.39 Less: Cost of funds (0.48%) (3.70) Net Interest Margin 3.73% 4.69 Less: Non-interest expense (3.05%) (3.56) Less: Provision for loan losses (0.12%) (0.29) Net loss before other income (0.56%) 0.84 Plus: Non-interest income 1.78% 1.13 Less: Taxes 0.23% (0.64) Equals: Net Profit or Loss (ROA) 0.99% 1.33 Spread Commercial Banks $1 Bil to $100 Mil 53

54 54 /6 9 54

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 Operating Expenses – Amort of Intang Asts Interest Income - COF + Non-Interest Income $355,825 - $4,781 ($442,846 - $37,881 + $108,915) Efficiency Ratio $351,044 X 100 = 68.31% $513,880

57 57

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. 59

60 Non-Performing Loans and Charge-offs $100 mil to $1 Bil Asset Category Normal 6/30/14 Delinquency0.75%1.59% Charge-offs0.40%0.21% Combined1.15%1.80% 60

61 61

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 (800)


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