Bank Financial Quarterly | IDC Financial Publishing, Inc.

Bank Financial Quarterly is One of the Nation’s Prime Sources of Bank Quality Ratings Since 1985

IDC’s Bank Financial Quarterly identifies each bank’s strengths and weaknesses by type of financial ratio, providing a summary rating from 300 (the highest) to 1 (the lowest). The summary rank is categorized 300-200 “Superior”, 199 to 165 “Excellent”, 164 to 125 “Average”, 124 to 75 “Below Average”, and 75 to 1 “Lowest Ratios”. Included in the CAMEL ratio analysis, IDC calculates a unique Net Operating Profit (After Tax) Return on Equity (ROE) along with its components, which provides a better measure of each institution’s performance, measuring, separately, operating and financial profits.

Sample Bank Case Study

The Sample Bank case is a study of a superior ranked bank that developed some problems as it dropped its rank from a “221” (superior) in the first quarter of 2005 to a rank of “116” (below average) in the fourth quarter of 2009. Management at the Sample Bank recognized the problems they were having, reacted quickly to take mitigating action and the banks rank recovered to “210” in the third quarter of 2012. Sample Bank’s current rank of “155” indicates management needs to again take actions to strengthen their balance sheet and enhance income.

Capital risk is determined by Tier I capital as a percent of assets and as a percent of risk based assets. Tier I & II capital as a percent of risk-based assets (total risk-based capital ratio) measures credit and interest rate risk, as well as estimates risk in the asset base. The Sample Bank’s Tier 1 capital as a % of assets (column 3) began the year 2005 at 9.8% and receded all the way to 7.2% in the third quarter of 2009. Subsequent earnings increases added to its capital base and Tier 1 capital rose to 9.3% by the second quarter of 2014. Total risk-based capital (column 4) in the first quarter of 2005 was 19.4% and dropped to 10.9% in the first quarter of 2009. It recovered from there to its present 15.3%.

Adequacy of Capital and reserves measures the levels of delinquent loans, nonaccrual loans, restructured and foreclosed assets relative to loan loss reserves and capital. Risk-adjusted assets as part of the risk-based capital ratio further define the quality of assets. The Sample Bank’s loans on non-accrual, restructured loans, and OREO as a percent of Tier 1 capital (column 8) was 11% at the end of the fourth quarter of 2009 and improved to 8% in the second quarter of 2014. The loan loss reserve as a percent of Tier 1 capital (column 6) remained stable at 7% of Tier 1 capital in the second quarter of 2005, the fourth quarter of 2009, and the current 8% in the second quarter of 2014, reflecting the bank’s ability to remain relatively risk-free with regard to non-performing assets.

Margins are the best measurement of management’s financial controls. Margins represent the spreads between 1) operating profit and net operating revenues, 2) after-tax return on earning assets and cost of funding, and 3) the return on equity compared to estimated cost of equity capital. The Sample Bank’s net interest margin (column 24) in the first quarter of 2005 was 3.75%, dropped to 3.24% by the fourth quarter of 2009, recovered to 3.71% by the fourth quarter of 2011, and has since receded to its current 3.36%. The operating profit margin (column 30) reflected a similar change dropping from 37.5% to 28.2%, recovering to 35.1%, and dropping to its current 22.9%. Management will need to take some action to improve their margin and stabilize their recovery.

Earning returns measure the success of the bank’s operating strategy. Ratios of revenue yields from investments, loans, and noninterest income with comparison to operating costs, less loan loss provision, plus net loan charge-offs, and net non-operating income ratios are the major components of the net operating after-tax return on earning assets (ROEA). Earnings from financial leverage measure the level of leverage and after-tax cost of funding compared to the after-tax return on earning assets (ROEA). Leverage returns (ROFL) measure the efficiency of the bank’s financial strategy. Operating assets are financed with the leverage of deposits and borrowings to Tier I capital and its comparative cost. The leverage multiplier illustrates the degree of leverage, while the leverage spread measures its cost relative to operating returns. The Sample Bank’s ROEA (column 32) fell from 2.54% in the first quarter of 2005 to .04% by the fourth quarter of 2009, rose to 1.71% by the fourth quarter of 2011, and decreased markedly to its current 1.16%. The return on financial leverage (ROFL) (column 38) dropped from 9.1% in the first quarter of 2005 to a negative 14.4% in the fourth quarter of 2009, recovered to 9.3% by the third quarter of 2011, and dropped to 5.8% in the third quarter of 2013. ROEA plus ROFL equals net operating ROE (column 15) of 6.9% in the third quarter of 2013, compared to a cost of equity (column 14) of 6.1%.

Liquidity measures (1) balance sheet cash flow as a percent of Tier I capital (column 9) and (2) loans compared to stable deposits and borrowings plus estimated unused lines of credit at the Federal Home Loan Bank (column 10). The Sample Bank’s balance sheet cash flow percentage was a positive 5% in the first quarter of 2005, negative 59% in the third quarter of 2009 and improved to at or near positive for the most current 14 quarters. Loans as a percent of stable deposits and borrowings rose through the study period from 53% to 70%.

Congratulations to a Sample Bank that is well capitalized, controls nonperforming assets, and maintains a high level of balance sheet liquidity to support future growth. Management will need to improve margins and enhance earnings to keep from experiencing financial troubles in the near future.