What is this Project’s Objective?
This project is designed to improve your ability to analyze a particular bank's performance. The emphasis should be to explore your bank from a regulator’s point of view. In that respect you should address the six CAMELS components and try to identify any "red flags" that could indicate potential problems in your bank.
The Excel file under the name of “Bank Financial Analysis” should be used to capture the financial data for your bank and to show the associated financial ratios. You should be able to find all your data in your bank’s Uniform Bank Performance Report
(UBPR).
Your written report should be no less than 5 pages long (typed, double-spaced) not including the Excel worksheet. The six CAMELS components are: Capital adequacy; Asset quality; Management quality; Earnings record; Liquidity position; and Sensitivity to market risk. Following is a more detailed listing of the items that you need to address:
C. Earnings
In this section, you need to evaluate earnings by assessing:
• The level, trend, and stability of earnings - Look for earnings fluctuations and try to determine the cause of those fluctuations.
• The quality and sources of earnings - Are the primary sources of income from normal banking activities that you can rely on in the future? Try to assess the amount that is attributable to non-recurring sources - like extraordinary gains or investment trading activities.
• The ability to augment capital through retained earnings - This factor is very important, especially in times of rapid growth or increasing risk.
• The exposure to market risks - For most banks, this exposure is centered in interest rate risk. Maintaining higher levels of interest rates risk can create dramatic swings in income and could have negative implications for future earnings.
• The provisions for loan losses - If the allowance for loan losses is not adequate for the risk identified in the loan portfolio, additional provisions will be necessary, which will lower net income.
Look at your bank’s Uniform Bank Performance Report and focus on some key earnings ratios that will help you monitor earnings performance. One fairly standard approach to this analysis is to follow what regulators typicaly refer to as the "Earnings Analysis Trail". It focuses on the following five items found on the Summary Ratios page of the UBPR under Earnings and Profitability.
Net Income
Logically, the first item to look at is the bottom line to determine how well the bank is doing overall. The line item listed as Net Income in the Earnings and Profitability section is also known as Return on Assets (ROA). The ratio is calculated by dividing net income (after all expenses and taxes) by average assets.
Net Interest Income
The second step on this earnings analysis trail is the line item Net Interest Income (NII). This ratio is calculated by subtracting total interest expense from total interest income and dividing the result by average assets.
Non-Interest Income
The line item for Non-Interest Income mainly consists of service charges and miscellaneous account fees and is usually the second major type of bank income. Like the other ratios we have seen, this ratio is measured as a percentage of average assets.
Overhead Expenses
Overhead is accounted for as Non-Interest Expense on the UBPR. This item includes all operating expenses except for interest expense and provisions for loan losses. This line item includes expenses such as salaries, depreciation, consulting fees, and supplies. This ratio is
more fully detailed on page 4 of the UBPR.
Provision for Loan Losses
Another item that you need to discuss in the Earnings and Profitability section is the Provision for Loan Losses. Your main concern here is whether the provisions are adequate to maintain the Allowance for Loan Losses at an appropriate level. If the allowance is too low relative to risk in the loan portfolio, additional provisions will be necessary, which must be taken out of earnings.
As you are discussing earnings and profitability, you should specifically address any items with significant changes. In that respect, you could answer questions such as:
- What has caused the change in net income? What is the reason for the increase or decrease in overhead expenses?
- Review the following ratios:
• Yield on Total Loans
• Personnel Expenses as a Percent of Average Assets
- Has the yield on total loans and leases increased or decreased during this period? At the same time what happened to the interest income as a percent of average assets (Summary Page)?
- What are the reasons for the rise or drop in Non-Interest Expense?
Finally, use your textbook’s continuing case assignment for chapter 6 and discuss some of the remaining profitability ratios shown there such as ROE; and the breakdowns of ROA; ROE; and net profit margin for your institution.
D. Asset Quality
The assessment of asset quality involves much more than simply calculating past due and adverse classification ratios. In addition to assessing trends in classified assets, delinquent loans, and credit concentrations, the asset quality component takes into account management's ability to underwrite and administer credits in a prudent and sound manner. In that respect, the regulators will examine a bank’s loan policies, loan portfolios and the adequacy of the allowance for loan and lease losses
The UBPR is a good starting point to begin extracting asset quality information. It is a very useful tool for identifying trends or outlying performance issues relative to a group of similar banks.
Examiners use the UBPR to plan for examinations by identifying areas with potential credit exposure. Nonetheless, the UPBR will only take you so far in painting a picture of asset quality. Several financial ratios relating to asset quality are available in the UBPR. These ratios provide detail on balance sheet composition, off-balance sheet commitments, delinquencies, charge-offs, and portfolio mix. Four ratios to focus on when assessing asset quality include:
1. Asset Growth Rate - This ratio details the change in total assets over the past 12 months.
2. Non-current Loans and Leases to Gross Loans and Leases - This ratio reflects the percentage of loans that are 90 days or more past due, or are no longer accruing interest.
3. Net Losses to Average Total Loans and Leases - This ratio presents the level of net losses, on an annualized basis, as a percentage of the total portfolio. It takes into consideration any recoveries on prior period losses.
4. Loan and Lease Allowance to Total Loans - This ratio measures the allowance available to absorb loan losses relative to total loans outstanding.
In relation to these ratios, answer the following questions:
- Asset Growth Rate - What is the rate of asset growth and how would you characterize this growth?
- What category dominated asset growth?
- Non-current Loans to Gross Loans - How would you characterize the level of delinquencies?
- Net Losses to Average Total Loans - What has the trend been?
- Loan and Lease Allowance to Total Loans and Leases - What conclusions can you draw about the adequacy of the allowance?
Of course, UBPR analysis is a starting point. You should also review your textbook which discusses the various bank assets in more detail.
Attachment:- Case Requirements.rar