Bank Management, 6th edition. Timothy W. Koch and S. Scott MacDonald Copyright 2006 by South-Western, a division of Thomson Learning

Transcription

1 Bank Management, 6th edition. Timothy W. Koch and S. Scott MacDonald Copyright 2006 by South-Western, a division of Thomson Learning ANALYZING BANK PERFORMANCE: USING THE UBPR Chapter 2 William Chittenden edited and updated the PowerPoint slides for this edition. 1

2 Balance Sheet Assets = Liabilities + Equity Balance sheet figures are calculated at a particular point in time and thus represent stock values. 2

3 Bank Assets Cash and due from banks Vault cash, deposits held at the Fed and other financial institutions, and cash items in the process of collection. Investment Securities Securities held to earn interest and help meet liquidity needs. Loans The major asset, generate the greatest amount of income, exhibit the highest default risk and are relatively illiquid. Other assets Bank premises and equipment, interest receivable, prepaid expenses, other real estate 3 owned, and customers' liability to the bank

4 Balance Sheet (assets): PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of BALANCE SHEET % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total ASSETS Loans: Real estate loans 1.2% 15,639, % 32.4% 20,701, % 4.0% 75, % 12.9% 85, % Commercial loans -8.4% 11,879, % 23.8% 14,707, % -5.8% 34, % 12.9% 38, % Individual loans -4.4% 2,501, % 52.6% 3,816, % 26.7% 8, % -5.2% 8, % Agricultural loans 9.2% % 57.0% 1, % 0.0% 0 0.0% 0.0% 0 0.0% Other LN&LS in domestic off % 3,022, % -0.8% 2,999, % 13.0% % 284.6% % LN&LS in foreign off. 15.6% 1,190, % 2.8% 1,222, % 0.0% 0 0.0% 0.0% 0 0.0% Gross Loans & Leases -4.6% 34,234, % 26.9% 43,449, % 2.2% 118, % 11.7% 131, % Less: Unearned Income 8.0% 44, % 0.2% 44, % 0.0% 0 0.0% 0.0% 0 0.0% Memo: Total loans -4.6% 34,189, % 27.0% 43,404, % 2.2% 118, % 11.7% 131, % Loan & Lease loss Allowance -5.8% 606, % -3.8% 583, % 6.7% 1, % 28.5% 1, % Net Loans & Leases -4.5% 33,582, % 27.5% 42,820, % 2.2% 116, % 11.5% 130, % Investments: U.S. Treasury & Agency securities 90.6% 5,574, % 15.9% 6,460, % 73.9% 34, % 24.8% 43, % Municipal securities -46.9% 7, % % 131, % -0.5% % -0.5% % Foreign debt securities % 0 0.0% 0% 0 0.0% 0.0% 0 0.0% 0% 0 0.0% All other securities 1.1% 8,804, % 3.0% 9,064, % #N/A 2, % -2.2% 2, % Interest bearing bank balances 16.4% 259, % 51.8% 393, % #N/A 4, % -57.5% 1, % Fed funds sold & resales -54.6% 1,106, % 56.2% 1,728, % 175.0% 7, % -21.4% 5, % Trading account assets -9.1% 935, % 78.3% 1,667, % 0.0% 0 0.0% 0.0% 0 0.0% Total Investments 8.7% 16,686, % 16.5% 19,446, % 111.1% 49, % 9.3% 53, % Total Earning Assets -0.5% 50,269, % 23.9% 62,267, % 20.6% 165, % 10.8% 183, % Nonint Cash & Due from banks -6.9% 2,926, % 8.5% 3,174, % -16.6% 13, % -10.7% 11, % Premises, fixed assets & capital lea 24.4% 1,039, % 2.5% 1,066, % 12.2% 5, % 2.2% 5, % Other real estate owned 21.8% 14, % 0.7% 14, % -84.3% % % 0 0.0% Investment in unconsolidated subs % 17, % -12.4% 15, % 0.0% 0 0.0% 0.0% 0 0.0% Acceptances and other assets 51.8% 7,754, % -6.2% 7,272, % 259.8% 7, % 13.2% 8, % Total Assets 4.0% 62,020, % 19.0% 73,809, % 18.6% 192, % 9.0% 210, % Average Assets During Quarter 6.8% 62,719, % 17.0% 73,391, % 17.5% 191, % 9.4% 209, %

5 Adjustments to total loans three adjustments are made to obtain a net loan figure. 1. Leases are included in gross loans. 2. Unearned income is deducted from gross interest received. 3. Gross loans are reduced by the dollar magnitude of a bank's loan-loss reserve, which exists in recognition that some loans will not be repaid. 5

6 Provisions for loan losses Recoveries Provisions for loan losses Reserve for Loan Losses Charge offs 6

7 Bank investments and FASB 115 Following FASB 115 a bank, at purchase, must designate the objective behind buying investment securities as either: Held-to-maturity securities are recorded on the balance sheet at amortized cost. Trading account securities are actively bought and sold, so the bank marks the securities to market (reports them at current market value) on the balance sheet and reports all gains and losses on the income statement. Available-for-sale, all other investment securities, are recorded at market value on the balance sheet with a corresponding change to stockholders equity as unrealized gains and losses on securities holdings; 7 no income statement impact.

8 Average assets, capital and loan loss data: PNC and Community NB PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Enter analysts name here Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of SUPPLEMENTAL DATA Pg # % Cha $ 1,000 Total % Cha $ 1,000 Total % Cha $ 1,000 Total % Cha $ 1,000 Total Average Assets % 60,890, % 69,596, % 176, % 200,271 Domestic Banking offices % % % % 6 Foreign Branches % % % % 0 Number of equivalent employees % 15, % 15, % % 71 SUMMARY OF RISK BASED CAPITAL Net Tier One 11A -0.49% 5,134, % -0.90% 5,088, % 14.19% 14, % 9.09% 15, % Net Eligible Tier Two 11A -9.20% 1,566, % 28.12% 2,007, % 6.70% 1, % 28.54% 1, % Tier Three 11A 36.19% (12,269) 0.0% % (62,334) -0.1% 0.00% 0 0.0% 0.00% 0 0.0% Deductions 11A -2.73% 6,689, % 5.15% 7,033, % 13.53% 15, % 10.69% 16, % Total-risk-based-capital 11A -2.73% 13,378, % 5.15% 14,067, % 13.53% 30, % 10.69% 33, % Total Risk-Weighted Assets 11A -1.95% 51,908, % 17.32% 60,897, % 12.72% 130, % 14.03% 148, % SUMMARY OF LOAN LOSS ACCOUNT Balance at beginning of period % 644, % -5.83% 606, % 38.87% 1, % 6.70% 1, % Gross Credit Losses % 255, % % 161, % % % % % Memo: Loans HFS Writedown % 26, % % 8, % 0.00% 0 0.0% 0.00% 0 0.0% Recoveries % 47, % 5.05% 49, % % % 72.73% % Net Credit Losses % 207, % % 111, % % % % % Provisions for Credit Losses % 176, % % 51, % 42.50% % % % Other Adjustments % (6,277) 0.0% % 37, % 0.00% 0 0.0% 0.00% 0 0.0% Balance at end of period % 606, % -3.79% 583, % 6.70% 1, % 28.54% 1, % Average Total Loans & Leases % 35,193, % 13.55% 39,960, % 5.43% 114, % 7.38% 123, % NON-CURRENT LN&LS 90 days and over past due % 72, % % 57, % % % % 0 0.0% Total Nonaccrual Ln&LS % 270, % % 141, % % % -9.17% % Total Non-current LN&LS % 343, % % 199, % % % % % Ln&Ls Days Past Due % 126, % % 94, % % % % 2, % Restructured LN&LS 90+ Days P/D 8 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% Restructured LN&LS Nonaccrual % % % 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% Current Restructured LN&LS 8 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% All other real estate owned % 14, % 0.7% 14, % -84.3% % % 0 0.0% 8

9 Bank liabilities Demand deposits Transactions accounts that pay no interest Negotiable orders of withdrawal (NOWs) and automatic transfers from savings (ATS) accounts Pay interest set by each bank without federal restrictions Money market deposit accounts (MMDAs) Pay market rates, but a customer is limited to no more than six checks or automatic transfers each month Savings and time deposits represent the bulk of interest-bearing liabilities at banks. 9

10 Bank liabilities (continued) Two general time deposits categories exist: Time deposits in excess of $100,000, labeled jumbo certificates of deposit (CDs). Small CDs, considered core deposits which tend to be stable deposits that are typically not withdrawn over short periods of time. Deposits held in foreign offices Balances issued by a bank subsidiary located outside the U.S. Purchased liabilities, (rate-sensitive borrowings): Federal Funds purchased Repos Other borrowings less than one year 10

11 Core versus volatile funds Core deposits are stable deposits that are not highly interest rate-sensitive. More sensitive to the fees charged, services rendered, and location of the bank. Includes: demand deposits, NOW accounts, MMDAs, and small time deposits. Large, or volatile, borrowings are liabilities that are highly rate-sensitive. Normally issued in uninsured denominations Ability to borrow is asset quality sensitive Includes: large CDs (over 100,000), deposits in foreign offices, federal funds purchased, repurchase agreements, and other borrowings with maturities less than one year.* *The UBPR also includes brokered deposits less than $100,000 and maturing within one year in the definition of net non-core liabilities. 11

12 Balance Sheet (liabilities): PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of BALANCE SHEET % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total LIABILITIES Demand deposits 2.6% 7,070, % 20.1% 8,488, % 12.6% 72, % 12.4% 81, % All NOW & ATS Accounts 9.9% 1,529, % 8.9% 1,666, % 15.5% 12, % 39.7% 17, % Money market deposit accounts 6.8% 24,502, % 8.8% 26,665, % 56.7% 46, % 5.3% 48, % Other savings deposits 5.0% 2,055, % 35.4% 2,782, % 7.3% 7, % 26.7% 9, % Time deposits under $100M -15.9% 6,242, % 13.1% 7,063, % 4.0% 24, % -14.4% 20, % Core Deposits 2.0% 41,400, % 12.7% 46,666, % 20.7% 163, % 9.2% 178, % Time deposits of $100M or more -17.6% 1,775, % 80.5% 3,205, % 4.9% 13, % 8.4% 14, % Deposits held in foreign offices 71.5% 2,371, % 26.3% 2,994, % 0.0% 0 0.0% 0.0% 0 0.0% Total deposits 3.2% 45,548, % 16.1% 52,866, % 19.3% 177, % 9.1% 193, % Fed funds purchased & resale 25.2% 499, % 221.8% 1,606, % 0.0% 1, % 0.0% 1, % FHLB borrowings < 1 Yr 898.2% 1,000, % % 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% Other borrowings inc mat < 1 yr 99.4% 2,264, % 34.5% 3,046, % 0.0% 0 0.0% 0.0% 0 0.0% Memo: S.T. non core funding 73.5% 7,111, % 25.7% 8,936, % 0.1% 7, % 28.7% 10, % Memo: S.T. Volatile liabilities 36.2% 6,911, % 57.0% 10,853, % 4.5% 14, % 7.8% 15, % FHLB borrowings > 1 Yr -90.0% 115, % -23.3% 88, % 0.0% 0 0.0% 0.0% 0 0.0% Other borrowings inc mat > 1 yr -2.9% 1,765, % 105.2% 3,624, % 0.0% 0 0.0% 0.0% 0 0.0% Acceptances & other liabilities -0.1% 3,864, % 18.7% 4,585, % -11.0% % 31.6% % Total Liabilities before Sub. No 4.6% 55,058, % 19.5% 65,818, % 19.1% 178, % 9.1% 194, % Sub. Notes & Debentures 16.2% 1,340, % 41.4% 1,895, % 0.0% 0 0.0% 0.0% 0 0.0% Total Liabilities 4.9% 56,398, % 20.1% 67,713, % 19.1% 178, % 9.1% 194, % All common and preferred capital -4.1% 5,622, % 8.4% 6,095, % 12.0% 14, % 8.2% 15, % Total Liabilities & Capital 4.0% 62,020, % 19.0% 73,809, % 18.6% 192, % 9.0% 210, % Memoranda: Officer, Shareholder Loans (#) 0.0% 2 0.0% 50.0% 3 0.0% -50.0% 1 0.0% 0.0% 1 0.0% Officer, Shareholder Loans ($) -19.4% 14, % 58.0% 22, % 31.7% 1, % 22.2% 2, % Non-investment ORE 21.8% 14, % 0.7% 14, % -84.3% % % 0 0.0% Loans Held for Sale -10.2% 1,378, % 20.9% 1,667, % 0.0% 0 0.0% 0.0% 0 0.0% Held-to Maturity Securities #N/A 2, % % 0 0.0% 36.7% 4, % -56.2% 1, % Available-for-Sale-Securities 23.4% 14,383, % 8.9% 15,656, % 89.4% 33, % 32.4% 44, % Total Securities 23.4% 14,385, % 8.8% 15,656, % 81.8% 37, % 22.9% 46, % All Brokered Deposits 14.2% 1,533, % 49.3% 2,289, % 0.0% 0 0.0% 0.0% 0 0.0%

13 Stockholders equity Subordinated notes and debentures: Notes and bonds with maturities in excess of one year. Stockholders' equity Ownership interest in the bank. Common and preferred stock are listed at par Surplus account represents the amount of proceeds received by the bank in excess of par when it issued the stock. Retained earnings equals accumulated net income not paid out as cash dividends 13

14 The income statement Interest income (II) Interest expense (IE) Interest income less interest expense equals net interest income (NII) Loan-loss provisions (PL) represent management's estimate of potential lost revenue from bad loans Noninterest income (OI) Noninterest expense (OE) noninterest expense usually exceeds noninterest income such that the difference is labeled the bank's burden Securities gains or losses (SG) Taxes 15

15 Income statement (interest): PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION Dec-03 % of Dec-04 % of Income Statement % Cha $ 1,000 Total % Cha $ 1,000 Total Interest Income: Interest and fees on loans -17.5% 1,730, % 8.3% 1,875, % Income from lease financing -20.6% 189, % -30.1% 132, % Memo: Fully taxable -17.7% 1,905, % 4.6% 1,993, % Tax-exempt -25.7% 14, % -3.2% 14, % Estimated tax benefit -27.7% 7, % -22.3% 5, % Income on Loans & Leases (TE) -17.8% 1,927, % 4.4% 2,013, % COMMUNITY NATIONAL BANK Dec-03 % of Dec-04 % of % Cha $ 1,000 Total % Cha $ 1,000 Total 0.0% 7, % 7.5% 8, % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 7, % 7.5% 8, % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 7, % 7.5% 8, % Other security inc. (data prior to 12/31/00 0.0% 0 0.0% 0.0% 0 0.0% U.S. Treasury & Agency securities 48.2% 34, % 221.4% 110, % Mortgage Backed Securities -0.7% 366, % -8.1% 337, % Estimated tax benefit 1.0% % 565.1% 3, % All other securities income -15.4% 117, % -31.2% 81, % Memo: Tax-Exempt Securities Income 3.7% 1, % 728.4% 8, % Investment Interest Income (TE) -2.4% 519, % 2.4% 532, % Interest on due from banks 43.8% 4, % -24.8% 3, % Interest on Fed funds sold & resales -32.4% 18, % 57.9% 29, % Trading account income 216.9% % % 20, % Other interest income 127.2% 39, % -47.2% 20, % Total interest income (TE) -14.2% 2,511, % 4.3% 2,620, % Interest Expense: Int on Deposits held in foreign offices -14.7% 17, % 144.0% 42, % Interest on CD's over $100M -29.5% 67, % 6.4% 72, % Interest on All Other Deposits: -30.5% 369, % 1.8% 376, % All NOW & ATS Accounts 0.0% 0 0.0% 0.0% 0 0.0% Money market deposit accounts 0.0% 0 0.0% 0.0% 0 0.0% Other savings deposits 0.0% 0 0.0% 0.0% 0 0.0% Time deposits under $100M 0.0% 0 0.0% 0.0% 0 0.0% Total interest exp. on deposits -29.8% 454, % 7.9% 490, % Interest on Fed funds purchased & resal 2.2% 13, % 204.9% 40, % Interest on Trad Liab & Oth Borrowings -59.0% 26, % 429.4% 137, % Interest on mortgages & leases 0.0% 0 0.0% 0.0% 0 0.0% Interest on Sub. Notes & Debentures -17.9% 55, % 52.1% 84, % Total interest expense -30.6% 549, % 37.0% 752, % Net interest income (TE) -8.1% 1,961, % -4.8% 1,867, % 0.0% 0 0.0% 0.0% 0 0.0% -6.2% % 28.3% % -12.6% % 62.8% % 23.5% % 81.0% % 28.1% % 80.5% % 28.1% % 80.5% % -7.4% % 46.9% 1, % 164.3% % 21.6% % -7.0% % -23.3% % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% % 13.3% % -0.6% 8, % 10.9% 9, % 0.0% 0 0.0% 0.0% 0 0.0% -19.2% % 6.4% % -20.5% 1, % 3.6% 1, % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% -20.2% 1, % 4.3% 1, % -52.2% % 90.9% % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% % -20.6% 1, % 5.0% 1, % 4.5% 7, % 12.1% 8, %

16 Income statement (noninterest): PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION Dec-03 % of Dec-04 % of Income Statement % Cha $ 1,000 Total % Cha $ 1,000 Total Noninterest Income: Fiduciary Activities -5.4% 291, % 1.6% 296, % Deposit service charges 4.8% 422, % 2.1% 431, % Trading rev, venture cap., securitize inc. 61.8% 88, % -24.4% 67, % Investment banking, advisory inc. 3.5% 562, % 32.7% 746, % Insurance commissions & fees -74.8% (660) 0.0% -1896% 11, % Net servicing fees -7.9% 35, % 45.3% 51, % Loan & lease net gains (losses) -13.4% 134, % -3.0% 130, % Other net gains (losses) -39.1% 10, % -88.8% 1, % Other noninterest income 10.5% 474, % 1.3% 479, % Total noninterest income 3.7% 2,018, % 9.8% 2,216, % Adjusted Operating Income (TE) -2.5% 3,980, % 2.6% 4,083, % Non-Interest Expenses: Personnel expense 5.7% 1,112, % 27.8% 1,421, % Occupancy expense 11.8% 352, % -0.6% 350, % Goodwill impairment 0.0% 0 0.0% 0.0% 0 0.0% Other Intangible Amortization -4.6% 4, % 186.5% 11, % Other Oper Exp (Incl intangibles) 10.9% 956, % 3.9% 994, % Total Noninterest Expenses 8.6% 2,425, % 14.5% 2,777, % Provision: Loan & Lease Losses -39.1% 176, % -70.8% 51, % Pretax Operating Income (TE) -11.5% 1,378, % -9.0% 1,254, % Realized G/L Hld-to-Maturity Sec. 0.0% 0 0.0% 0.0% 0 0.0% Realized G/L Avail-for-Sale Sec. 12.6% 89, % -44.5% 49, % Pretax Net Operating Income (TE) -10.4% 1,468, % -11.2% 1,304, % Applicable Income Taxes -13.4% 490, % -22.1% 381, % Current Tax Equivalent Adjustment -26.4% 7, % 15.4% 9, % Other Tax Equivalent Adjustments 0.0% 0 0.0% 0.0% 0 0.0% Applicable Income Taxes (TE) -13.6% 498, % -21.5% 390, % Net Operating Income -8.6% 970, % -5.9% 913, % Net Extraordinary Items 0.0% 0 0.0% 0.0% 0 0.0% Net Income -8.6% 970, % -5.9% 913, % Cash Dividends Declared 87.5% 750, % 6.7% 800, % Retained Earnings -66.7% 220, % -48.5% 113, % Memo: Net International Income 0.0% 0 0.0% 0.0% 0 0.0% Memo: Total operating income -6.7% 4,619, % 5.8% 4,886, % Memo: Net operating income -2.5% 3,980, % 2.6% 4,083, % COMMUNITY NATIONAL BANK Dec-03 % of Dec-04 % of % Cha $ 1,000 Total % Cha $ 1,000 Total 0.0% 0 0.0% 0.0% 0 0.0% 16.7% 1, % 30.5% 1, % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% -66.7% 1 0.0% 100.0% 2 0.0% 0.0% 0 0.0% 0.0% 0 0.0% % 0 0.0% 0.0% 0 0.0% % (73) -0.7% -75.3% (18) -0.2% -31.9% % -15.8% % -16.6% 1, % 18.2% 1, % 0.1% 9, % 13.1% 10, % -2.4% 4, % 3.2% 4, % 4.5% 1, % 2.2% 1, % 0.0% 0 0.0% 0.0% 0 0.0% 0.0% % 0.0% % -2.8% 2, % 3.3% 2, % -1.4% 7, % 3.1% 7, % 42.5% % -12.3% % -8.9% % 118.0% 1, % 0.0% 0 0.0% 0.0% 0 0.0% 110.8% % % 0 0.0% 2.4% 1, % 75.6% 1, % -2.2% % 80.6% % 23.5% % 81.0% % 0.0% 0 0.0% 0.0% 0 0.0% -1.1% % 80.6% % 4.3% % 73.0% 1, % 0.0% 0 0.0% 0.0% 0 0.0% 4.3% % 73.0% 1, % % 0 0.0% 0.0% 0 0.0% 58.8% % 73.0% 1, % 0.0% 0 0.0% 0.0% 0 0.0% % 10, % 9.8% 11, % 0.1% 9, % 13.1% 10, %

17 Interest income the sum of interest and loan fees earned on all of a bank's assets. Interest income includes interest from: 1. Loans and leases 2. Deposits held at other institutions, 3. Investment securities Taxable and municipal securities 4. Trading account securities 18

18 Noninterest income has increased significantly and consists of fees & other revenues for services Fiduciary activities Deposit service charges Trading revenue, venture cap., securitize inc. Investment banking, advisory inc. Insurance commissions & fees Net servicing fees Loan & lease net gains (losses) Other net gains (losses) 19 Other noninterest income

19 Noninterest expense composed primarily of: Personnel expense: Salaries and fringe benefits paid to bank employees Occupancy expense : Rent and depreciation on equipment and premises, and Other operating expenses: Utilities Deposit insurance premiums 20

20 Noninterest expense Expenses and loan losses directly affect the balance sheet. The greater the size of loan portfolio, the greater is operating overhead and PLL. Consumer loans are usually smaller and hence more costly (non-interest) per dollar of loans. 21

21 Return on equity (ROE = NI / TE) the basic measure of stockholders returns ROE is composed of two parts: Return on Assets (ROA = NI / TA), represents the returns to the assets the bank has invested in Equity Multiplier (EM = TA / TE), the degree of financial leverage employed by the bank 22

22 Return on assets (ROA = NI / TA) can be decomposed into two parts: Asset Utilization (AU) income generation Expense Ratio (ER) expense control ROA = AU - ER = (TR / TA) - (TE / TA) Where: TR = total revenue or total operating income = Int. inc. + Non-int. inc. + SG and TE = total expenses = Int. exp. + Non-int. exp. + PLL + Taxes 23

23 ROA is driven by the bank s ability to: generate income (AU) and control expenses (ER) Income generation (AU) can be found on the UBPR (page 1) as: Int. Inc. Non. int. Inc. Sec gains (losses) AU TA TA TA Expense Control (ER) can be found on the UBPR (page 1) as: Int. Exp. Non int.exp. PLL ER * TA TA TA Note, ER* does not include taxes. 24

24 Bank Performance Model Returns to Shareholders ROE = NI / TE INCOME Interest Non Interest Rate Composition (mix) Volume Fees and Serv Charge Trust Return to the Bank ROA = NI / TA EXPENSES Degree of Leverage EM =1 / (TE / TA) Interest Overhead Prov. for LL Taxes Other Rate Composition (mix) Volume Salaries and Benefits Occupancy Other 25

25 Expense ratio (ER = Exp / TA) the ability to control expenses. Interest expense / TA Cost per liability (avg. rate paid) Int. exp. liab. (j) / $ amt. liab. (j) Composition of liabilities $ amt. of liab. (j) / TA Volume of int. bearing debt and equity Non-interest expense / TA Salaries and employee benefits / TA Occupancy expense / TA Other operating expense / TA Provisions for loan losses / TA Taxes / TA 26

26 Asset utilization (AU = TR / TA): the ability to generate income. Interest Income / TA Asset yields (avg. rate earned) Interest income asset (i) / $ amount of asset (i) Composition of assets (mix) $ amount asset (i) / TA Volume of Earning Assets Earning assets / TA Noninterest income / TA Fees and Service Charges Securities Gains (Losses) Other income 27

27 Aggregate profitability measures Net interest margin NIM = NII / Earning Assets (EA) Spread Spread = (Int Inc / EA) (Int Exp / Int bear. Liab.) Earnings base EB = EA / TA Burden / TA (Noninterest Exp. - Noninterest Income) / TA Efficiency ratio Non int. Exp. / (Net int. Inc. + Non-int. Inc.) 28

28 Financial ratios PNC and Community National Bank UBPR for PNC PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC BANK PG 1 CALC BANK PG 1 CALC BANK PG 4 CALC BANK PG 4 ROE: Net Income / Average total equity % 16.56% 14.41% 15.59% 15.26% 14.55% 5.48% 5.56% 11.56% 8.63% 8.67% 11.72% ROA: Net Income / ata % 1.59% 1.28% 1.31% 1.31% 1.31% 0.41% 0.41% 1.07% 0.63% 0.63% 1.09% AU: Total Revenue / ata 1 calc 7.59% 7.59% 6.45% 7.02% 7.02% 6.21% 6.10% 6.10% 6.50% 5.90% 5.91% 6.23% ER: Total expenses (less Taxes) / ata 1 calc 5.18% 5.17% 4.51% 5.15% 5.14% 4.23% 5.47% 5.48% 5.01% 4.93% 4.94% 4.73% EM: ata / Avg, Total Equity 6 calc 10.59x 10.48x 11.20x 11.59x 11.47x 10.65x 13.37x 13.76x 10.85x 13.78x 13.97x 10.67x EB: Earning Assets / ata % 82.60% 89.84% 82.85% 82.92% 90.08% 85.43% 86.74% 91.45% 86.83% 86.98% 91.76% NIM: Net interest margin (te) % 3.82% 3.51% 3.32% 3.18% 3.52% 4.95% 4.80% 4.33% 4.82% 4.74% 4.36% Spread (te) 3 calc 3.74% 3.62% 3.36% 3.15% 3.02% 3.37% 4.39% 4.25% 3.97% 4.30% 4.25% 4.04% Efficiency Ratio % 60.86% 57.73% 68.01% 67.97% 57.92% 82.72% 82.75% 66.06% 75.35% 75.34% 65.99% Burden / ata 1 calc 0.67% 0.66% 1.12% 0.81% 0.81% 1.16% 3.37% 3.37% 2.33% 2.94% 2.94% 2.39% Non Interest Income / Noninterest exp. 1 calc 83.24% 83.42% 62.03% 79.79% 79.70% 59.86% 21.08% 21.08% 29.18% 24.18% 24.23% 26.23% EXPENSES: ER*: Expense ratio (Expense components) 5.18% 0.00% 5.17% 4.51% 5.15% 0.00% 5.14% 4.23% 5.47% 0.00% 5.48% 5.01% 4.93% 0.00% 4.94% 4.73% Total Interest expense / ata % 0.90% 1.29% 1.08% 1.08% 1.20% 0.82% 0.82% 1.50% 0.76% 0.76% 1.31% Memo: Interest expense / Avg. Earn as % 1.07% 1.41% 1.34% 1.28% 1.31% 0.95% 0.92% 1.61% 0.87% 0.85% 1.41% Noninterest Expenses / ata % 3.98% 2.95% 3.99% 3.99% 2.89% 4.27% 4.27% 3.29% 3.88% 3.88% 3.24% Personnel expense % 1.83% 1.37% 2.04% 2.04% 1.38% 2.38% 2.38% 1.79% 2.16% 2.16% 1.78% Occupancy expense % 0.58% 0.38% 0.50% 0.50% 0.36% 0.71% 0.71% 0.48% 0.64% 0.64% 0.47% Other Oper Exp (Incl intangibles) % 1.58% 1.13% 1.43% 1.44% 1.08% 1.17% 1.18% 1.00% 1.07% 1.07% 0.98% Provision: Loan & Lease Losses / ata % 0.29% 0.27% 0.07% 0.07% 0.14% 0.39% 0.39% 0.22% 0.30% 0.30% 0.18% Income Taxes / ata #N/A 0.82% 0.83% 0.66% 0.56% 0.57% 0.67% 0.21% 0.21% 0.42% 0.34% 0.34% 0.41% INCOME: AU: Asset Utilization (Income components): 7.59% 7.59% 6.45% 7.02% 7.02% 6.21% 6.10% 6.10% 6.50% 5.90% 5.91% 6.23% Interest income / ata % 4.12% 4.57% 3.77% 3.77% 4.46% 5.08% 5.08% 5.52% 4.97% 4.97% 5.37% Memo: Avg, yield on earning assets % 4.89% 4.98% 4.66% 4.46% 4.88% 5.91% 5.73% 5.95% 5.69% 5.59% 5.78% 29 Noninterest income / ata % 3.32% 1.83% 3.18% 3.18% 1.73% 0.90% 0.90% 0.96% 0.94% 0.94% 0.85% Realized security gains (losses) / ata % 0.15% 0.05% 0.07% 0.07% 0.02% 0.12% 0.12% 0.02% 0.00% 0.00% 0.01%

29 Interest expense composition, rate and volume effects for PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC BANK PG 1 CALC BANK PG 1 CALC BANK PG 4 CALC BANK PG 4 Interest Expense: Composition, Rate and Volume Effects Rate: Avg, interest cost of interest bearing li % 1.27% 1.62% 1.50% 1.44% 1.51% 1.51% 1.48% 1.98% 1.39% 1.34% 1.74% Memo: Interest expense / Earning assets % 1.07% 1.41% 1.34% 1.28% 1.31% 0.95% 0.92% 1.61% 0.87% 0.85% 1.41% Volume: All Interest bearing debt (avg.) / ata % 70.78% 80.81% 73.70% 74.97% 80.65% 53.76% 55.17% 75.51% 54.29% 56.69% 74.88% Mix and Cost of Individual Liabilities:* Total deposits (avg.) / ata: % 73.84% 67.79% 72.45% 72.30% 68.32% 91.72% 91.94% 85.07% 92.02% 91.96% 84.46% Cost (rate): Int bearing Total deposits % 1.22% 1.39% 1.18% 1.14% 1.25% 1.52% 1.49% 1.90% 1.38% 1.33% 1.66% Core deposits (avg.) / ata % 68.16% 53.90% 64.84% 64.29% 54.64% 84.26% 84.50% 72.07% 85.00% 84.90% 71.52% All other deposits (avg.) / ata 6-calc 55.93% 55.41% 42.13% 53.38% 53.19% 43.03% 45.73% 45.52% 54.88% 46.77% 47.73% 53.88% Trans (NOW&ATS) Accts (avg.) / ata % 2.23% 1.81% 2.35% 2.15% 1.92% 6.55% 6.58% 10.37% 7.43% 7.02% 10.60% Cost (rate): Trans (NOW&ATS) Acts 3 #N/A 0.90% 0.60% #N/A 0.86% 0.62% #N/A 0.29% 0.63% #N/A 0.28% 0.59% MMDA's and other sav. Accts (avg) / ata 6-calc 42.29% 42.15% 30.73% 41.23% 41.28% 32.75% 25.67% 25.71% 22.70% 28.07% 29.57% 22.85% Cost (rate): Other savs deposits* 3 #N/A 0.57% 0.70% #N/A 0.60% 0.69% #N/A 0.90% 1.08% #N/A 0.98% 1.00% Time deposits under $100M (avg.) / ata % 11.03% 9.59% 9.80% 9.76% 8.36% 13.51% 13.23% 21.81% 11.27% 11.14% 20.43% Cost (rate): All oth time dep. (CD<100M 3 #N/A 3.12% 2.41% #N/A 2.78% 2.03% #N/A 2.51% 2.80% #N/A 2.01% 2.43% Volatile (S.T non core) liab (avg.) / ata % 11.47% 23.24% 13.08% 12.11% 23.42% 8.03% 4.10% 11.90% 7.52% 4.84% 12.21% Large CDs (inc. brokered) (avg.) / ata % 3.14% 9.02% 3.67% 3.76% 8.99% 7.46% 7.44% 12.41% 7.02% 7.06% 12.39% Cost (rate): CD's over $100M % 3.66% 2.38% 2.89% 2.81% 2.17% 2.83% 2.79% 2.72% 2.82% 2.78% 2.40% Fed funds purchased & resale (avg.)/ ata % 0.99% 8.16% 1.55% 3.18% 8.00% 0.56% 0.55% 1.05% 0.50% 0.55% 1.07% Cost (rate): Fed funds pur & resale % 1.10% 1.15% 3.84% 1.37% 1.41% 1.10% 1.10% 0.82% 2.10% 1.75% 0.98% Memo: All brokered deposits (avg.) / ata % 2.19% 2.29% 2.81% 3.00% 2.81% 0.00% 0.00% 0.51% 0.00% 0.11% 0.84% All common and preferred capital (avg.) / ata % 9.54% 8.93% 8.63% 8.72% 9.39% 7.48% 7.27% 9.22% 7.26% 7.16% 9.37% 30

30 Interest income composition, rate and volume effects for PNC and Community National Bank PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC BANK PG 1 CALC BANK PG 1 CALC BANK PG 4 CALC BANK PG 4 Interest Income: Composition, Rate and Volume Effects Rate: Avg, yield on ata Memo: Avg. yield on earn. assets (rate) % 4.89% 4.98% 4.66% 4.46% 4.88% 5.91% 5.73% 5.95% 5.69% 5.59% 5.78% Volume: Earn assets (avg.) / ata % 82.60% 89.84% 82.85% 82.92% 90.08% 85.43% 86.74% 91.45% 86.83% 86.98% 91.76% Non earning assets (avg.) / ata 6-calc 17.14% 17.39% 9.75% 17.15% 17.07% 9.64% 14.57% 13.27% 8.25% 13.17% 13.03% 7.93% Mix and Yield on Individual Assets:* Total Loans (Gross loans - unearn inc.) (avg % 57.17% 57.69% 57.13% 57.25% 58.22% 65.76% 64.10% 66.45% 62.05% 61.33% 67.80% Yield (rate): Total Loans & Leases (te) % 5.48% 5.66% 5.04% 5.04% 5.47% 6.89% 6.89% 6.91% 6.90% 6.90% 6.58% Total Investments (avg.) / ata: 6-calc 26.33% 26.46% 26.43% 26.60% 26.52% 26.50% 20.36% 23.28% 21.82% 25.50% 26.35% 20.98% Total investment securities (avg.) / ata 6-calc 21.41% 21.90% 22.56% 22.12% 22.03% 23.03% 16.43% 14.97% 17.89% 20.83% 20.78% 17.81% Yield (rate): Total invest secs. (TE) % 3.81% 4.18% 3.54% 3.51% 3.98% 2.94% 3.32% 4.08% 3.00% 2.92% 3.91% Yield (rate): Total invest secs. (Book) % 3.81% 4.00% 3.52% 3.48% 3.84% 2.86% 3.24% 3.75% 2.91% 2.83% 3.61% Trading account assets (avg.) / ata % 1.63% 0.39% 1.92% 2.09% 0.34% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 31

31 Fundamental risks : Credit risk Liquidity risk Market risk Operational risk Capital or solvency risk Legal risk Reputational risk 32

32 Credit risk the potential variation in net income and market value of equity resulting from nonpayment or delayed payment on loans and securities Three Question need to be addressed: 1. What has been the loss experience? 2. What amount of losses do we expect? 3. How prepared is the bank? 33

33 Credit ratios to consider What has been the loss experience? Net loss to average total LN&LS Gross losses to average total LN&LS Recoveries to avg. total LN&LS Recoveries to prior period losses Net losses by type of LN&LS What amount of losses do we expect? Non-current LN&LS to total loans Total Past/Due LN&LS - including nonaccrual Non-current & restruc LN&LS / Gross LN&LS Current - Non-current & restruc/ Gr LN&LS Past due loans by loan type 34

34 Credit ratios to consider (continued) How prepared are we? Provision for loan loss to: average assets and average total LN&LS LN&LS Allowance to: net losses and total LN&LS Earnings coverage of net loss 35

35 Credit risk ratios : PNC and Community National PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC BANK PG 1 CALC BANK PG 1 CALC BANK PG 4 CALC BANK PG 4 Credit Risk Gross loss / Avg. tot LN&LS % 0.73% 0.53% 0.40% 0.40% 0.36% 0.54% 0.54% 0.26% 0.21% 0.21% 0.20% Net loss / Avg. tot LN&LS % 0.59% 0.41% 0.28% 0.28% 0.25% 0.53% 0.53% 0.21% 0.20% 0.20% 0.16% Recoveries / Avg. tot LN&LS % 0.13% 0.12% 0.12% 0.12% 0.11% 0.01% 0.01% 0.06% 0.02% 0.02% 0.05% Recoveries to prior credit loss % 0.00% 19.03% 22.26% #NA 19.5% 0.00% 19.52% 23.76% #NA 0.00% 6.7% 6.75% 29.21% #NA 0.00% 3.1% 3.08% 24.53% #NA 90 days past due / EOP LN&LS 8A 0.21% 0.21% 0.13% 0.13% 0.13% 0.10% 0.16% 0.16% 0.13% 0.00% 0.00% 0.10% total Nonaccrual LN&LS / EOP LN&LS 8A 0.79% 0.79% 0.66% 0.33% 0.33% 0.46% 0.19% 0.19% 0.47% 0.16% 0.16% 0.41% total Noncurrent / EOP LN&LS 8A 1.00% 1.00% 0.83% #NA 0.46% 0.46% 0.59% #NA 0.35% 0.35% 0.66% #NA 0.16% 0.16% 0.55% #NA LN&LS Allowance to total LN&LS % 1.78% 1.44% 1.34% 1.35% 1.27% 1.07% 1.07% 1.25% 1.23% 1.23% 1.20% LN&LS Allowance / Net losses 7 2.9x 2.92x 4.18x 5.2x 5.23x 7.51x 2.1x 2.08x 11.89x 6.7x 6.71x 14.52x LN&LS Allowance / total nonaccural LN&L x 2.24x 2.73x 2.92x 4.12x 3.73x 3.05x 5.49x 4.35x 7.77x 7.77x 5.63x Earn Coverage of net losses x 7.44x 10.92x 11.61x 11.61x 19.94x 2.57x 2.57x 23.89x 10.38x 10.38x 30.80x Net Loan and lease growth rate % 0.00% -4.55% 10.14% 27.51% 0.00% 27.51% 17.96% 2.16% 0.00% 2.16% 11.61% 11.49% 0.00% 11.49% 14.24% 36

36 Liquidity risk the variation in net income and market value of equity caused by a bank's difficulty in obtaining cash at a reasonable cost from either the sale of assets or new borrowings Banks can acquire liquidity in two distinct ways: 1. By liquidation of assets Composition of loans & investments Maturity of loans & investments Percent of loans and investments pledged as collateral 2. By borrowing Core deposits Volatile deposits Asset quality & stockholders equity 37

37 Liquidity risk ratios : PNC and Community National PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 4 CALC 0.00% BANK PG 4 Liquidity Risk %Total (EOP) Assets (except where noted) Total equity % 9.07% 8.95% 8.26% 8.26% 9.74% 7.29% 7.29% 9.28% 7.23% 7.23% 9.42% Core deposits % 66.75% 53.75% 64.84% 63.23% 54.19% 84.26% 84.95% 71.85% 85.00% 85.04% 71.10% S.T Non-core funding 10 #N/A 11.47% 23.24% #N/A 12.11% 23.42% #N/A 4.10% 11.90% #N/A 4.84% 12.21% Net loans & leases / Total Deposits % 73.73% 87.72% 81.00% 81.00% 88.28% 65.90% 65.90% 78.94% 67.35% 67.35% 81.42% Net loans & leases / Core Deposits % 81.11% % 91.76% 91.76% % 71.36% 71.36% 93.85% 72.89% 72.89% 97.58% Avg. Available for sale securities / ata % 21.90% 21.11% 22.12% 22.03% 21.00% 14.44% 13.39% 15.88% 19.38% 19.04% 15.80% Short-term investments 10 #N/A 2.73% 6.25% #N/A 3.02% 5.23% #N/A 5.99% 5.41% #N/A 5.72% 5.26% Pledged securities 10 #N/A 0.00% 46.50% 49.08% #N/A 0.00% 51.76% 54.78% #N/A 0.00% 29.25% 40.34% #N/A 0.00% 28.49% 41.20% 38

38 Market risk the risk to a financial institution s condition resulting from adverse movements in market rates or prices Market risk arises from changes in: Interest rates Foreign exchange rates Equity, commodity and security prices 39

39 Interest rate risk the potential variability in a bank's net interest income and market value of equity due to changes in the level of market interest rates Example: $10,000 Car loan 4 year fixed-rate car loan at 8.5% 1 year CD at 4.5% Spread 4.0% But for How long? Funding GAP GAP = $RSA - $RSL, where $RSA = $ amount of assets expected to reprice in a give period of time. In this example: GAP 1yr = $0 - $10,000 = - $10, This is a negative GAP.

40 Foreign exchange risk the risk to a financial institution s condition resulting from adverse movements in foreign exchange rates Foreign exchange risk arises from changes in foreign exchange rates that affect the values of assets, liabilities, and off-balance sheet activities denominated in currencies different from the bank s domestic (home) currency. This risk is also often found in off-balance sheet loan commitments and guarantees denominated in foreign currencies; foreign currency translation risk 41

41 Equity and security price risk change in market prices, interest rates and foreign exchange rates affect the market values of equities, fixed income securities, foreign currency holdings, and associated derivative and other offbalance sheet contracts. Large banks must conduct value-atrisk analysis to assess the risk of loss with their trading account portfolios. 42

42 Operational risk measures the cost efficiency of the bank's activities; i.e., expense control or productivity; also measures whether the bank has the proper procedures and systems in place. Typical ratios focus on: total assets per employee total personnel expense per employee Non-interest expense ratio There is no meaningful way to estimate the likelihood of fraud or other contingencies from published data. A bank s operating risk is closely related to its operating policies and processes and whether is has adequate controls. 43

43 Operational risk ratios: PNC and Community National PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 4 CALC 0.00% BANK PG 4 Operational Risk Total Assets / Number of employees 3 $4.09 $ 4.02 $ 5.17 $4.71 $ 4.44 $ 6.09 $3.00 $ 2.75 $ 2.95 $2.98 $ 2.84 $ 3.08 Personnel expense / number of employee x 72.06x 60.48x 90.68x 85.48x 65.26x 65.46x 60.03x 48.27x 61.47x 58.58x 50.10x Efficiency ratio % 60.86% 57.73% 68.01% 67.97% 57.92% 82.72% 82.75% 66.06% 75.35% 75.34% 65.99% 44

44 Capital risk closely tied to asset quality and a bank's overall risk profile The more risk taken, the greater is the amount of capital required. Appropriate risk measures include all the risk measures discussed earlier as well as ratios measuring the ratio of: Tier 1 capital and total risk based capital to risk weighted assets Equity capital to total assets Dividend payout, and growth rate in tier 1 capital 45

45 Definitions of capital Tier 1 capital is: Total common equity capital plus noncumulative preferred stock, plus minority interest in unconsolidated subsidiaries, less ineligible intangibles. Risk-weighted assets are: The total of risk-adjusted assets where the risk weights are based on four risk classes of assets. Importantly, a bank's dividend policy affects its capital risk by influencing retained earnings. 46

46 Capital risk ratios : PNC and Community National PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK Dec-03 Dec-04 Dec-03 Dec-04 RISK RATIOS Pg # CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 1 CALC 0.00% BANK PG 4 CALC 0.00% BANK PG 4 Capital Risk Tier 1 Leverage Capital / Total Assets 11A 8.28% 8.37% 7.67% 6.89% 7.14% 7.71% 7.27% 7.31% 8.97% 7.27% 7.29% 9.11% Tier 1 Capital / Risk-weighted assets 11A 9.91% 9.89% 11.13% 8.65% 8.36% 11.17% 10.73% 10.73% 12.64% 10.27% 10.27% 12.64% Total RBC / Risk weighted Assets 11A 12.91% 12.89% 13.08% 11.95% 11.55% 12.98% 11.70% 11.70% 13.80% 11.35% 11.35% 13.76% Equity Capital / Total Assets % 9.07% 8.95% 8.26% 8.26% 9.74% 7.29% 7.29% 9.28% 7.23% 7.23% 9.42% Dividend Payout % 77.30% 57.26% 87.58% 87.58% 46.73% 0.00% 0.00% 30.77% 0.00% 0.00% 29.34% Growth rate in total equity capital % -4.09% 10.34% 8.42% 8.42% 20.28% 11.99% 11.99% 10.99% 8.20% 8.20% 11.32% Equity growth less asset growth % 0.00% -8.09% 0.59% % 0.00% % 4.55% -6.56% 0.00% -6.56% 0.41% -0.83% 0.00% -0.83% 0.28% 47

47 Legal risk the potential that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively affect the operations or condition of the banking organization Legal risk includes: Compliance risks Strategic risks General liability issues 48

48 Reputational risk Reputational risk is the potential that negative publicity regarding an institution s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions. 49

49 Strategies for Maximizing Shareholder Wealth Asset Management Composition and Volume Liability Management Composition and Volume Management of off-balance sheet activities Net interest margin management Credit risk management Liquidity management Management of non-interest expense Securities gains/losses management 50 Tax management

50 CAMELS Capital Adequacy Measures bank s ability to maintain capital commensurate with the bank s risk Asset Quality Reflects the amount of credit risk with the loan and investment portfolios Management Quality Reflects management s ability to identify, measure, monitor, and control risks 51

51 CAMELS (continued) Earnings Reflects the quantity, trend, and quality of earnings Liquidity Reflects the sources of liquidity and funds management practices Sensitivity to market risk Reflects the degree to which changes in market prices and rates adversely affect earnings and capital 52

52 CAMELS Ratings Regulators assign a rating of 1 (best) to 5 (worst) in each of the six categories and an overall composite rating 1 or 2 indicates a fundamentally sound bank 3 indicates that a bank shows some underlying weakness that should be corrected 4 or 5 indicates a problem bank 53

53 Average Performance Characteristics of Banks by Business Concentration and Size ROE and ROA (up to $10 billion in assets) increases with bank size Employees per dollar of assets decreases with bank size Larger banks have lower efficiency ratios than smaller banks Smaller banks: have proportionately more core deposits and fewer volatile liabilities than larger banks have a proportionately larger earnings base than larger banks have proportionately lower charge-offs than 54 larger banks

54 Bank Performance Measure by Size Assets Size < $100M $100M - $1B $1B - $10B > $10B Trend with Size All Commercial Banks Number of institutions reporting 3,655 3, ,630 % of unprofitable institutions % of institutions with earn gains then Performance ratios (%) Return on equity generally Return on assets then 1.31 Pretax ROA then 1.92 Equity capital ratio Net interest margin Yield on earning assets Cost of funding earn assets Earning assets to total assets Efficiency ratio Burden ratio Noninterest inc to earn assets Noninterest exp to earn assets Net charge-offs to LN&LS LN&LS loss provision to assets

55 Bank Risk Measures by Size Assets Size < $100M $100M - $1B $1B - $10B > $10B Trend with Size All Commercial Banks Asset Quality Net charge-offs to LN&LS Loss allow to Noncurr LN&LS then LN&LS provision to net charge-offs Loss allowance to LN&LS Net LN&LS to deposits then Capital Ratios Core capital (leverage) ratio Tier 1 risk-based capital ratio Total risk-based capital ratio Structural Changes New Charters Banks absorbed by mergers Failed banks

56 Performance Characteristics of Banks by Business Concentration and Size Wholesale Banks Focus on loans for the largest commercial customers and purchase substantial funds from corporate and government depositors Retail Banks Focus on consumer, small business, mortgage, and agriculture loans and obtain deposits form individuals and small businesses 57

57 Profitability Measures of Banks by Business Concentration All Institu Credit Card Inter - national Ag. Lending Asset Concentration Groups Commercial summer Con Mort - gage Lending Lending Other spec. < $1B All Other <$1B All Other > $1B # of institutions reporting 8, ,730 4, , Commercial banks 7, ,725 4, , Savings institutions 1, Performance ratios (%) Return on equity Return on assets Pretax ROA Equity capital ratio Net interest margin Yield on earning assets Cost of funding earn assets Earning assets to total assets Efficiency ratio Burden Noninterest inc to earn assets Noninterest exp to earn assets LN&LS loss provision to assets

58 Risk Measures of Banks by Business Concentration All Institu Credit Card Inter - national Ag. Lending Asset Concentration Groups Commercial summer Con Mort - gage Lending Lending Other spec. < $1B Asset Quality Net charge-offs to LN&LS Loss allow to Noncurr LN&LS LN&LS provs. to net charge-offs Loss allowance to LN&LS Net LN&LS to deposits Capital Ratios Core capital (leverage) ratio Tier 1 risk-based capital ratio Total risk-based capital ratio Structural Changes New Charters Banks absorbed by mergers Failed institutions SOURCE: FDIC Quarterly Banking Profile, All Other <$1B All Other > $1B 59

59 Financial Statement Manipulation Off-balance sheet activities Enron and Special-Purpose Vehicles Window dressing Eliminate Fed borrowing prior to financial statement reporting date Increase asset size prior to year-end Preferred stock Meets capital requirements but causes NIM, NI, ROE, and ROA to be overstated 60

60 Financial Statement Manipulation (continued) Non-performing loans Banks may lend borrower funds to make payments on past due loans, understating non-performance status Allowance for loan losses Management discretion and IRS regulations may be in conflict 61

61 Financial Statement Manipulation (continued) Securities gains and losses Banks often classify all investment securities as available for sale, overstating any true gains or losses Non-recurring sales of assets This type of transaction is not part of the bank s daily activities and typically cannot be repeated; thus it overstates earnings 62

62 Bank Management, 6th edition. Timothy W. Koch and S. Scott MacDonald Copyright 2006 by South-Western, a division of Thomson Learning ANALYZING BANK PERFORMANCE: USING THE UBPR Chapter 2 William Chittenden edited and updated the PowerPoint slides for this edition. 84