ANALYZING BANK PERFORMANCE

Transcription

1 ANALYZING BANK PERFORMANCE The Balance Sheet PNC Bank vs Community National Bank Asset selection - liquidity loans vs investments types of loans Sources of funds - equity vs liabilities checkable deposits vs non-transaction accounts core deposits vs deposits that pay money market rates (volatile liabilities)

2 % of Total Assets PNC CNB LIQUIDITY Primary (Cash & dep's at other banks) Secondary (US gov't, Fed funds & RP's) EARNING ASSETS Net loans & leases Total investments Treasuries Other securities Fed Funds LOAN TYPES Business loans & leases Real estate Consumer

3 LEVERAGE Equity DEPOSIT COMPOSITION Checkable (DD, NOW, ATS) Core deposits Volatile liabilities Long-term debt

4 The Income Statement where NI [(II & IE) % (nonii & nonie)] & PL & T NI NetII & BURDEN & PL & T II = interest income IE = interest expense Net II = II - IE NonII = non-interest income (fees and trading profits) Burden = nonie - nonii nonie = non-interest expenses (operating expenses) PL = provision for loan losses T = taxes

5 BANK REVENUES Expressed as a % of Total Revenue (Interest Income + Non-interest Income) PNC CNB INTEREST INCOME Interest and fees on loans & leases Interest on securities Treasury & agency securities Municipals Deposits, Fed funds & RPs NON-INTEREST INCOME

6 BANK EXPENSES & NET INCOME PNC CNB INTEREST EXPENSE Interest on domestic deposits < $100, > $100, Interest on foreign deposits Interest on other borrowings NON-INTEREST EXPENSE Personnel expenses Occupancy expenses PROVISION FOR LOAN LOSS NET INCOME

7 The link between the balance sheet and the income statement NI j N n 1 N j n 1 M A n j L m % E m 1 M N (r n ( A n ) & j (c m ( L m ) & j PL(A n ) & Burden & T m 1 n 1 The importance of the interrelationships in understanding changes in NII and NI Changes in NII due to changes in loan and deposit rates vs changes in the composition of loans and deposits The impact of a change in interest rates for a given composition of loans and deposits The impact of a shift in loan composition e.g., switch from consumer loans to commercial real estate loans The impact of a shift in deposit composition e.g., switch from local deposit markets to negotiable CD's

8 Changes in Burden and the Provision for Loan Losses due to changes in loan and deposit composition The impact of a shift in loan composition on PL e.g., switch from consumer loans to commercial real estate loans The impact of a shift in loan and deposit composition on Burden e.g., switch from local deposit markets to negotiable CD's

9 Bankers sometimes talk about instituting efforts to sell mutual funds, market and trade derivative securities, and conduct investment banking activities. Where would the revenue and costs from these activities enter into the profit function? What does the traditional split between NII and profits from other sources? What split do the executives of these banks envision? Does increasing emphasis on these businesses affect the profit from other activities? E.g., mutual funds will take some deposits away from the traditional banking part of the financial services firm. If the firm doesn't pursue these options, will it retain the business anyway? Even if it will, services should be offerred in the form that offers the greatest profit. What is the most profitable mix of products?

10 FINANCIAL STATEMENT ANALYSIS OF PNC & COMMUNITY NATIONAL BANK How profitable are PNC and CNB? assessment must be made relative to some benchmark - e.g., banks within the same size class (Uniform Bank Performance Report) PNC Return on Equity 15.52% (18.11) Equity Multiplier (X) or E/TA (%) 12.00X or 8.33% PNC Bank PNC Peers Community National Bank CNB 17.55% 18.34% (20.15) 12.90X or 7.75% 12.55X or 7.97% CNB Peers 12.90% 10.80X or 9.26% Return on Assets 1.53% 1.38% 1.62% 1.23% Profit Margin 14.67% (14.59) 14.60% 17.81% (17.84) 14.24% Asset Utilization 10.49% 9.45% 9.08% 8.64% PNC generates more revenue, has the same profit margin, and has less leverage CNB generates more revenue, has a higher profit margin, and has more leverage Using UBPR # s

11 PNC PNC Peers Interest Income/TA 8.09% 7.37% Interest expense/ta Avg interest cost of liabilities Net Interest Income/TA Noninterest Expense/TA Personnel & occupancy/ta Noninterest Income Provision for loan loss/ta # PNC has higher interest income, higher interest expense, and higher Net Interest Income than peers. # PNC has higher noninterest expense, higher noninterest income, and a higher burden. # Provision for loan loss looks substantially lower. Incomplete measure of credit risk profile. # PNC s advantage in Net Interest Income more than offsets its greater burden and causes higher profitability.

12 SOURCES OF RISK 1. Credit risk - chance that the borrower will not pay interest or repay principal on a timely basis. Examine using Net Charge-offs = gross charge-offs - recoveries Allowance for Loan Losses = accumulation set aside to reflect anticipated losses due to default Provision for Loan Losses = periodic allocation to Loss Reserve Past Due Loans = loans for which contracted payments (principal or interest) have not been made within 90 days of due date but are still accruing interest Nonaccrual Loans = loans that are past due and are no longer accruing interest Noncurrent loans = past due loans + nonaccrual loans Growth Rate in Loans Provision for Loan Losses and Loss Reserve reflect expectations. Charge-offs, Nonaccrual Loan, and Past Due Loan figures reflect actual experience with each loan. Loss Reserve is reported in the balance sheet. Provision for Loan Losses is reported in the income statement. Charge-offs are not directly reported but can be calculated as PL(t) - [LR(t) - LR(t-1)]. CREDIT RISK

13 PNC CNB UBPR Peer UBPR Peer % of Avg Total Loans Gross charge-offs 0.83% 0.66% Recoveries Net charge-offs % of End of year Loans Past due loans 0.53% 0.23% 2.29% 0.10% Nonaccrual loans Noncurrent loans Provision for loan losses Allowance for loan losses Allowance/Net charge-offs 3.51X 4.21X 16.58X 10.08X Allowance/Nonaccrual 3.49X 3.39X na na

14 RECOGNIZING BAD LOANS STEP 1. Record as an expense the portion of loans that bank believes will not be collected. This step is implemented during each accounting period. Account Debit Credit Provision for loan losses xxxxx Alllownce for loan losses xxxxx This reduces Net Income, Net Loans, and Total Assets by the amount of the anticipated default, $xxxxx. STEP 2. Banks makes decision that a specific loan will not be collected and must be eliminated from its accounts. This step is implemented whenever a bank decides that all or part of a loan are uncollectible. Account Debit Credit Allowance for loan losses zzzzz Loans - defaulted borrower zzzzz This reduces Gross Loans by the amount that the bank deems is uncollectible. The Reserve for potential loan defaults is also reduced. Net Income, Net Loans, and Total Assets are unaffected by this step. The amount in STEP 1 equals or exceeds the amount in STEP 2.

15 2. Liquidity Risk - the risk that the bank cannot meet payment obligations in a timely and cost effective manner. 3 components: total funding needs, stock of liquid assets and ability to access new deposits. Measured by Debt to Assets to measure total funding needs Short-term securities/total Assets bank holds to measure stock of liquid assets. Core deposits/total Assets and Volatile Liabilities/Total Assets to measure stability of funding sources. 3. Market Risk - the sensitivity of earnings or equity value to market prices/rates. Interest rates, exchange rates, stock prices, commodity prices, etc Must be analyzed in a relative sense -- a comparison of assets and liabilities. Any sensitivity on one side of the balance sheet that is matched by an offsetting sensitivity on the other does not expose the bank to risk. Any sensitivity that is not matched does expose the bank to risk of changes in interest rates.

16 4. Operating risk - efficiency and productivity of the bank. Inefficiency can be a source of low profitability. In measuring, focus on expense control by looking at Total Assets/Number of Employees, Average salary per employee, Occupancy expenses/non-interest expense. Importance of understanding the impact of type of business on operational efficiency of banks. 5. Capital Risk - risk that the bank might become insolvent. 2 aspects to risk of insolvency leverage decision - equity to assets. risk profile from above Insolvency can come about as a result of large defaults and adverse movements in market prices. Costs of illiquidity can adversely affect the value of the bank's equity if fire sales of assets are required. Lack of profits can come about because of being an inefficient producer of bank services.