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
% of Total Assets
PNC CNB LIQUIDITY
Primary (Cash & dep's 5.78 8.78
at other banks)
Secondary (US gov't, 7.54 29.23
Fed funds & RP's)
EARNING ASSETS
Net loans & leases 75.42 58.22
Total investments 12.75 29.40
Treasuries 6.58 16.63
Other securities 3.83 0.17
Fed Funds 0.96 12.60
LOAN TYPES
Business loans & leases 23.97 27.64
Real estate 33.39 20.02
LEVERAGE Equity 8.33 8.21 DEPOSIT COMPOSITION Checkable (DD, NOW, 12.73 41.07 ATS) Core deposits 54.70 81.81 Volatile liabilities 29.08 9.43 Long-term debt 7.89 0.55
NI ' [(II & IE) % (nonII & nonIE)] & PL & T NI ' NetII & BURDEN & PL & T
The Income Statement
where
II = interest income
Net II = II - IE IE = interest expense
NonII = non-interest income (fees and trading profits)
Burden = nonIE - nonII nonIE = non-interest expenses (operating expenses)
PL = provision for loan losses T = taxes
BANK REVENUES
Expressed as a % of Total Revenue (Interest Income + Non-interest Income)
PNC CNB
INTEREST INCOME 77.66 85.67
Interest and fees on loans & leases 69.17 65.11
Interest on securities 8.49 20.55
Treasury & agency securities 5.24 11.84
Municipals 0.14 0.00
Deposits, Fed funds & RPs 0.69 8.27
BANK EXPENSES & NET INCOME
PNC CNB
INTEREST EXPENSE 38.17 25.40
Interest on domestic deposits
< $100,000 17.23 20.64
> $100,000 3.88 4.75
Interest on foreign deposits 1.54 0.0
Interest on other borrowings 15.51 0.0
NON-INTEREST EXPENSE 38.17 52.66
Personnel expenses 16.36 26.56
Occupancy expenses 5.33 7.73
PROVISION FOR LOAN LOSS 1.06 1.65
j N n'1 An ' j M m'1 Lm % E NI ' j N n'1 (rn ( An) & j M m'1 (cm ( Lm) &j N n'1
PL(An) & Burden & T
The link between the balance sheet and the income statement
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
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
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.
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 Bank Community National
Bank PNC PNC Peers CNB CNB Peers Return on Equity 15.52% (18.11) 17.55% 18.34% (20.15) 12.90% Equity Multiplier (X) or E/TA (%) 12.00X or 8.33% 12.90X or 7.75% 12.55X or 7.97% 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
PNC PNC Peers
Interest Income/TA 8.09% 7.37%
Interest expense/TA 3.98 3.53
Avg interest cost of liabilities 5.08 4.66
Net Interest Income/TA 4.11 3.84
Noninterest Expense/TA 3.98 3.59
Personnel & occupancy/TA 2.26 1.95
Noninterest Income 2.33 2.06
Provision for loan loss/TA 0.11 0.29
# 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.
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)].
PNC CNB
UBPR Peer UBPR Peer
% of Avg Total Loans
Gross charge-offs 0.83% 0.66% 0.32 0.22
Recoveries 0.24 0.20 0.25 0.06
Net charge-offs 0.59 0.45 0.07 0.13
% of End of year Loans
Past due loans 0.53% 0.23% 2.29% 0.10%
Nonaccrual loans 0.50 0.50 1.12 0.38
Noncurrent loans 1.03 0.76 3.41 0.64
Provision for loan losses 0.14 0.43 0.26 0.26
Allowance for loan losses 1.76 1.65 1.12 1.27
Allowance/Net charge-offs 3.51X 4.21X 16.58X 10.08X
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.
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.
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.
