Question

Below is a common size income statement for Bank of Colorado (headquartered in Fort Collins) (listed as Bank) for its Uniform Bank Performance Statement with each item as a % of Total Average Assets for the Bank and for its Peers (i.e., the average for other similar size banks) for 2018 and 2019.                     

                                                                  2019                       2018

All items as % of Total Assets             Bank    Peers      Bank       Peers   

Interest Income (IR%)                         3.94        4.21        3.84        4.07

Interest Expense(IE%)                      0.69        0.87        0.43        0.64

    Net Interest Income (NIM%)           3.25        3.34        3.41         3.43

Non-interest Revenues (NIR%)         0.95       0.85        0.74         0.92

Non-Interest Expense (NIE%)           2.30       2.47        2.34         2.50

       Burden %                                   1.35        1.62        1.60         1.58

Provision for Loan Losses (PLL%)    0.01       0.11         0.06        0.12

Pretax Oper. Income (OROA%)     1.89        1.61        1.75         1.73

Equity to Assets% (Tier 1 cap. Ratio)   9.12       10.46       8.93       10.44

  

Equity Mulitplier (EM) (Assets/Equity)

=(1/ (Tier 1 Capital Ratio as a fraction)   10.97     9.56        11.20       9.58

  

Operating ROE % (OROA x EM        20.7     15.39      19.60        16.38         

   

1. OROA Trend Analysis for Bank of Colorado: Explain why Bank of Colorado’s OROE went up in 2019 based on the trends for its NIM%, Burden%, PLL%, and EM.  

2. NIM Analysis for Bank of Colorado: Explain why Bank of Colorado’s NIM fell in 2019, including a discussion of the trends in its IR%, and IE%, and the likely type of funding gap that Bank of Colorado has. The Peers Bank also had a fall in the NIM with a rise in rates, what type of funding gap does this suggest for the Peers.

3. Burden Analysis for Bank of Colorado: Explain why Bank of Colorado’s Burden% fell in 2019 including a discussion of the trends in its NIR% and NIE%.

4. Peer Comparison Analysis: Explain why Bank of Colorado’s ROE was higher than the Peers in 2019 including a discussion of differences in Bank of Colorado’s IR%, IE%, NIR%, NIE%, PLL%, and EM.   What strengths & weaknesses does this comparison reveal for Bank of Colorado versus the Peers?

5. Asset Utilization Comparison: What was Colorado Banks’s asset utilization (AU) in 2019, and what was the Peer asset utilization in 2019? (Hint AU = IR% + NIR%)

6. Net Profit Margin Comparison:  Given the OROA & AU, what was the NPM for Colorado Bank in 2019 and for the Peer Banks in 2019? Hint: (NPM = OROA/AU (as a fraction)]

        g. Do a Dupont Analysis for why Colorado Bank had a higher OROE than the Peers in 2019? (based on trends in NPM, AU, and EM; i.e., OROE = NPM x AU x EM).   

Answer 1

Part A:

OROA Trend Analysis: The OROA i.e. pre-tax operating income increased in the year 2019 due to the reduction in burden % which hints at reduction in bad loans in the year for the bank and an increase in non-interest revenues for the bank. The individual trends have been discussed below:

1) NIM%: Decreased reducing the OROA

2) Burden%: Reduced considerably hinting at better selection and management of loans

3) PLL%: As the bad loans reduced, the provisions for the bad loans reduced as well, leading to a better pre-tax operating margin for the bank

4) EM: The equity multiplier suggests an increase in equity as a source of capital, but this is an end of period data point, hence it can be a result of accumulated earnings generated by the bank, not yet paid as dividend.

Hence, a decrease in burden and provisions complemented by an increase in the non-interest revenue helped the bank in achieving a better pre-tax operating margin.

Part B:

NIM Analysis: The decrease in policy rates would have led to a decrease in the NIM. With a decreased policy rate the interest income and expense is both likely to decrease, but the net interest income takes a hit in a larger proportion depleting the net interest margins for the bank. Broadly, a funding gap cannot be analysed except the above inference from the data.

Part C:

Burden Analysis for Bank of Colorado: With a decrease in interest rates, banks experience an increase in the loans being sourced leading to a broader base of clients asking for loans, usually in terms leading to an increase in delinquency rates as well. But, the bank in context was able to follow a stringent check on their loan book leading to a decrease in the burden on banks, while in general its peers showed an increase in burden as it would have generally been observed. The bank’s shareholders would apprise of the facts leading to an increase in share price for the bank.

Part D:

Peer Comparison Analysis: The bank in context was able to contain its burden in an environment of falling policy rates implying good management of its loan books as compared to its peers. The capitalisation metrics do suggest a lower tier 1 capital for the bank as compared to its peers, implying a higher equity multiplier, though a risk broadly, but a comparatively high tier 1 equity capital on absolute basis but lower in relative terms to its peers help the bank generate a greater multiplier effect on its earnings, hence helping the bank to fetch a much higher ROE as compared to its peers. In contrast to the above strengths, the bank’s lower tier 1 capital is a weakness in hard times as compared to its peers in a long-term scenario. The bank has also improved upon the sources of revenue, as there is an commendable increase in non-interest revenue which will act as a strength in times of decreasing interest rates.

Part E:

Asset Utilization Comparison:

Bank: It has increased to 4.89% from 4.58% due to an increase in the non-interest revenue sources. It is a welcome development diversifying sources of revenue.

Peers: It has increase to 5.06% from 4.99% due to an increase in the non-interest revenue sources.

Broadly, the bank lags in asset utilisation to its peers but a commendable jump in asset utilization suggesting a catch-up reaffirms the faith in the management.

Part F:

Net Profit Margin Comparison:

Bank: 1.89/4.89=0.3865%

Peers: 1.61/5.06=0.318%

Part G:

OROE = NPM x AU x EM

By Du-Pont Analysis, the OROE for bank in comparison to its peers is higher due to a higher NPM and EM as compared to its peers. It’s AU is lower, but it has caught up heavily in the current year leading to an overall increase in OROE (as the lower AU is more than compensated by the higher NPM and EM).