advanced denis laplante july 28, 2016 bank analysis with ... · carrying value of non-performing...

Advanced Bank Analysis With Application

Denis Laplante July 28, 2016 [email protected]

mailto:[email protected]

Today’s Agenda

I. Net Interest Income / Average Balance Sheet Analysis II. Quality of Earnings III. Efficiency Ratio Adjustments & Operating Leverage IV. Signals in Credit Land - Beyond the Asset Quality Ratios V. Normalizing Earnings Copyright © 2016 S&P Global. Knowledge Center, a part of S&P Global Market Intelligence, a

division of S&P Global Inc.

I. Net Interest Income Analysis – Average Balance Sheet

SCHEDULE HAS A WEALTH OF INFORMATION Detail on Earning Asset Growth & Deposit Growth - • Loan Growth - Breakdown of Commercial & Consumer Loan categories • Changes in Investment Securities • Deposit Growth by Deposit Category Detail on Net Interest Margin Components–

• Earning Asset Yields

• Loan & Securities Yields

• Deposit and Borrowing Costs - Cost of Interest-Bearing Liabilities

-21bps

+1bp

-22bps -23bps

-16bps

-36bps

+$2.0B

+$8.0B

+$5.4B

+$5.0B $8.2B

-$1.2B

+$4.4B

Positive Mix Shift

+$3.4B

-$1.4B

I. Analysis of NII / Average Balance Sheet

8

FITB - Other Observations -leading to more questions to ask management

• C&I loan yields down 33bps vs. 2013 - FITB’s largest loan category • Fifth Third increased its securities book by about $5.4 billion or 33% in 2014 and yields increased.

• FITB increased Long-term debt by 63% or more than $5.0 billion. • Automobile loans were relatively flat but that was accompanied by a 33bp decline in yields.

• Due to price competition? Specific to any geography or by industry? Changing mix? • Did they extend maturities? How much

did duration increase? • What is the purpose behind extending

maturities? Matched funding for investments? Locking up long term funding?

• Is this deliberate? Are pricing and terms getting too aggressive in the space?

II. Quality of Earnings

Why do we care about the quality of earnings ?

Copyright © 2016 S&P Global. Knowledge Center, a part of S&P Global Market Intelligence, a division of S&P Global Inc.


Why do we care about the quality of earnings ? Impact on Earnings Growth - overstating / understating results - comparisons vs. peer groups Impact on Perceived Value of the Company – over-earning /under-earning? Impact on Operating Performance Ratios - peer group comparisons



Key Asset Quality Ratios: Types of Non- Recurring Items • Securities Gains • Gain or Loss on Divestiture of a

Business • Gain on Building Sale ---------------------------------------------

• Provision for loan losses vs. Net Charge-offs

Adjust Revenue and Expenses to arrive at Operating Earnings Adjust Operating Ratios – vs. historical results & peer groups


III. Efficiency Ratio Adjustments & Operating Leverage

12

EFFICIENCY RATIO = Non-Interest Expense / Total Revenue

EFFICIENCY RATIO = ( Non-Interest Expense – Non-recurring exp.) ---------------------------------------------------------------------------- Total Revenue - Securities G/L - Non-recurring income

III. Potential Adjustments to the Efficiency Ratio

13

1) Provision for Unfunded Loan Commitments - Expense item

• Required to segregate Reserves for Unfunded Loan Commitments • Distorts Analysis on Credit and Efficiency ratios

2) Other Real Estate Owned Expense (OREO) - Expense item

• Foreclosed property expense – asset write-downs & cost of maintaining property • During periods of real estate credit stress – can distort the efficiency ratio

3) Intangible Amortization - Expense item

• Non-cash charge and really should be excluded from the efficiency ratio.

Operating Expense Items

14

2015 2014 2013 2012 2011 2010 2009 2008

FDIC insurance and other taxes $99 $89 $127 $114 $201 $242 $269 $73

Loan and lease 118 119 158 183 195 211 234 188

Losses and adjustments 55 188 221 187 129 187 110 105

Marketing 110 98 114 128 115 98 79 84

Affordable housing impairment 145 135 108 90 85 100 83 67

Professional service fees 70 72 76 56 58 77 63 102

Travel 54 52 54 52 52 51 41 54

Postal and courier 45 47 48 48 49 48 53 54

Operating Lease 74 67 57 43 41 41 39 32

OREO expense 24 17 16 21 34 33 24 11

Recruitment and education 33 28 26 28 31 31 30 33

Data processing 45 41 42 40 29 24 21 14

Insurance 17 16 17 18 25 42 50 30

Intangible amortization 2 4 8 13 22 43 57 56

Supplies 16 15 16 17 18 24 25 31

Visa litigation reserve - - - - - - (73) (99)

Provision for unfunded comm. 4 (27) (17) (2) (46) (24) 99 98

Other, net 194 178 185 169 186 166 167 138

Total other non-interest expense 1,105 1,139 1,264 1,374 1,224 1,394 1,371 1,089

Fifth Third Bancorp – Components of Other Non-Interest Expense (years ended Dec 31)

Exercise – Citizens Financial Group Efficiency Adjustments & Operating Leverage

15

Using the Financial Statements for Citizens Financial Group - • Make the Revenue Adjustments to Calculate the Efficiency Ratio

• Make the Expense Adjustments to Calculate the Efficiency Ratio

• Calculate the growth rates for Adjusted Operating Expenses and Total Revenue

• Did Citizens Financial achieve positive operating leverage on an adjusted basis?

Assumptions: $8 million in branch sale gains in Q3:15 No Intangibles Expense in Non-Interest Expense No Provision for Unfunded Commitments in Non-Interest Expense No OREO expense in Non-Interest Expense

Exercise –CFG - Efficiency adj. & Operating Leverage

16

Net Interest Income $856 $820

Fee Income 353 341

Total Revenue (unadjusted) 1,209 1,161 4.1% Adjustments:

Adjusted Revenue

Non-Interest Expense (unadj) 798 810 -1.5% Adjustments:

Adjusted Expenses

Reported Efficiency Ratio 66.0% 69.8%

Adjusted Efficiency Ratio

CFG – Adjusted Efficiency / Operating Leverage

17

Net Interest Income $856 $820

Fee Income 353 341

Total Revenue (unadjusted) 1,209 1,161 4.1%

Adjustments:

Securities gains (2) (2)

Branch sale gains (8) --

Adjusted Revenue 1,199 1,159 +3.5%

Non-Interest Expense (unadj) 798 810 -1.5%

Adjustments:

Restructuring Charges -- (21)

Adjusted Expenses 798 789 +1.1%

Reported Efficiency Ratio 66.0% 69.8%

Adjusted Efficiency Ratio 66.6% 68.1%

Positive Operating Leverage +240bps

IV. Signals in Credit Land

Key Asset Quality Ratios: 1. Non-Performing Assets -------------------------------- Total Loans & OREO 2. Net Charge-Offs ----------------------------- Average Total Loans Focus on Trends and Peer Group Comparisons

Reserve Coverage Ratios: 3. Allowance for Credit Losses ----------------------------------- EOP Total Loans

4. Allowance for Credit Losses ----------------------------------- Non-Performing Loans 5. Allowance for Credit Losses ------------------------------------ Net Charge-Offs


IV. Signals in Credit Land

Beyond Traditional Ratio Analysis

1. Reaching for Growth

2. Inflows of Non-Performing Loans / Trends in Watch List

3. Trends in Past Due Loans

4. Recoveries / Gross Charge-Offs

5. Carrying Value of Non-Performing Assets

6. Portfolio Granularity

7. Shared National Credit Exam

8. Merger Accounting: Loan Portfolios


1. Reaching for Growth

Rapid Portfolio Growth- “If it Grows like a Weed –

it probably is a weed”

Broker Generated Loans - Home Equity, 1-4 Family Mortgages, etc. –

Out of Market

Aggressive Credit Card Offerings • Out of Market • Below Usual Credit Scores Norms

Out-of-Market Loan Production Offices (LPOs) - C&I Loans

Be Wary of Community Banks participating in Syndicated

Leveraged Lending

New Specialty Lending Initiatives

Equipment Finance Asset-Based Lending

First time underwriting Sub-Prime Credit Portfolios – Auto / CC


2. Non-Performing Loan (NPL) Inflows & Trends in Watch List

Represent Early Warning Signals for Changes in Loan Quality Trends

Helps Identify Inflection Points in Trends - Very Difficult in Practice

Watch List: Criticized & Classified Credits - Special Mention Substandard Doubtful


2. Non-Performing Loan (NPL) Inflows Warning Signs


2. NPL Inflows - Warning Signs


2. Inflows of Non-Performing Loans

Comerica (in millions)

Q1:16 Q4:15 Q3:15 Q2:15 Q1:15 Q4:14

ANALYSIS OF NON-ACCRUAL LOANS

Nonaccrual loans at beginning of period $367 $357 $349 $266 $273 $329

Loans transferred to nonaccrual 446 105 69 145 39 41

1) Nonaccrual - gross charge-offs (75) (49) (31) (31) (21) (16)

2) Loans transferred to accrual status 0 0 0 0 (4) (18)

3) Nonaccrual business loans sold (21) 0 0 (1) (2) (24)

4) Payments/Other (36) (46) (30) (30) (19) (39)

Nonaccrual loans at end of period $681 $367 $357 $349 $266 $273


2. Watch List Trends



• Another Possible Early Warning Tool • Delinquencies feed Non-Performing Loans and Credit Losses

• Past Due Loans can rise without an Increase in Non-Performing loans • Example: Comerica – Indirect Auto business



Comerica CREDIT QUALITY

Three Months Ended (in millions, except per share data)

Mar 31 2016

Dec 31 2015

Sept 30 2015

June 30 2015

Total nonperforming assets $714 $391 $381 $370

Loans past due 90 days & accruing 13 17 5 18

Net loan charge-offs 58 51 23 18

Allowance for loan losses 724 634 622 618

Reserve for unfunded commitments 46 45 48 50

Total allowance for credit losses 770 679 670 668

Allowance for credit losses/Total Lns. 1.56% 1.38% 1.37% 1.34%

Net loan charge-offs/Average Loans 0.49% 0.42% 0.19% 0.15%

NPAs/Loans & OREO 1.45% 0.80% 0.78% 0.74%

Allowance for credit losses/NPLs 112% 179% 182% 185%


4. Recoveries / Gross Charge-Offs

Higher recovery rates imply more conservative loss recognition policies. Caveats – Portfolio composition is a factor Unsecured vs. Secured Lending Consumer vs. Commercial


4. Recoveries – Possible Sign of Conservative Credit Policies


5. Carrying Value of Non-Performing Assets

• Banks do not necessarily disclose this number

• Ask Question - What is the Carrying Value of Non-Performing Assets?

• Compare Carrying Value vs. Contractual Value – Might offset need for Reserves

• Can Gain Insights from Discussions with Chief Credit Officers

• OREO Write down Policies



• Risk Profile - Diversification by Borrower

• Legal Lending Limit (LLL) - 15% of Capital

• Internal House Limits on Loans vs. Legal Lending Limit

• Does bank have many large borrower relationships?

• Diversification by Industry

• Geographic diversity - Challenging for Community Banks



Hypothetical Bank - $5 Billion Assets

Common Equity (10.0%) or $500 Million

Legal Lending Limit = 15% of Capital or $75 Million

House Limit Might Be = $15-20 Million

House Limit Exceptions


7. Shared National Credit Exam (SNCE)

• Annual Centralized Review of Large Credits by Examiners

• Process Initiated in 1977 - for Efficiency and Consistency

• Minimum size credits of $20 million

• Shared by 3 or more institutions

• Results - Usually disclosed Q2 / Q3 every year.


7. Shared National Credit Exam (SNCE)


Regulatory Guidance on Leveraged Lending

• Updated March 2013 -

• Leverage Lending -

• Set Debt/EBITDA guidance limits – 6x

• Require banks to stress test leveraged loans

• Urged Banks to Develop Meticulous loan policies on Leveraged lending

• Early Regulatory Intervention

Earnings

Before Interest Taxes Depreciation Amortization


7. Syndicated Credit / Shared National Credit Exam

• When Syndicated Credits Go Bad - Sometimes You Find Out Which Banks Have Exposure

• As Sample size grows – Possibly allows you to identify Outlier Banks • Discussion with Chief Credit Officers can help ferret out information • Example: FleetBoston Financial • Does Not Help You Much in Evaluating Community Bank credit



41

Total Loans $2,412,898

Allowance 28,877

Allowance/Loans 1.20%

NPAs / Loans & OREO 1.36%

NCOs / Average Loans .52%

Allowance / NPLS 107%

Allowance / NCOs 250%

Sterling- Pre-Acquisition (FY Sept 2013) Sterling- Post Acquisition – Dec Quarter

Sterling’s Acquisition: Loans $1,698,108 Allowance for Loan losses $22,000


Allowance 30,612

Allowance/Loans .74%






42


Allowance $ 30,612

Allowance/Loans .74%





What it looks like: What it should look like:


Allowance $ 52,612

Allowance/Loans 1.28%





Sterling’s Acquisition: Loans $1,698,108 Allowance for Loan losses $22,000

Sterling- Post Acquisition - Proforma Sterling- Post Acquisition – Dec Quarter

V. Normalizing Earnings

Why Try to Normalize Earnings?


Normalizing Earnings – Non-Severe Conditions

• Understand the Core Earnings Power of Bank

• Current Earnings Understated or Overstated? • Valuation Purposes – Is the Bank Properly Valued? • Assess the Takeover Value Potential


Normalizing Earnings

FOUR MAJOR FACTORS TO CONSIDER:

1) Are Net Interest Margins Unusually Depressed? 2) Unusually High or Low Credit Costs ?

3) Efficiency Opportunities ? 4) Can Excess Capital Be Deployed?


Normalized Earnings Exercise – Citizens Financial Group (CFG)

1) Evaluate the 4 Factors for Normalizing Citizens Financial’s Earnings

2) Use CFG’s First Quarter 2016 Financials as a Baseline. 3) Use Financial Disclosures / Peer Group Norms / Historical ratios

4) Make appropriate adjustments


Normalized Earnings Exercise – Citizens Financial Group (CFG) 1) Estimate CFG’s Normalized Net Income 2) Estimate CFG’s Normalized Earnings Per Share 3) Estimate CFG’s Normalized Return on Assets


Citizens Financial Group – Q1:16 Earnings & Balance Sheet

($ Millions)

Net Interest Income $904

Provision for loan losses

91

Fee Income 330

Operating Expenses

811

Pretax Income 332

Taxes 113

Net Income Preferred dividends

223 7

Net Income Available

216

Securities gains 9

Non-recurring gains 0

Non-recurring expenses 0

Net Interest Margin 2.86%

($Million s)

Average Loans $100,262

Average Earning Assets 126,165

Average Assets 138,780

Net Charge-offs $83

NCO/Average Loans .33%

Allowance for Credit Losses $1,282

ACL/EOP Loans 1.27%

NPAs/Loans & OREO 1.12%


1. Net Interest Income Adjustment

Interest Rate Environment vs. 2005

2005 July 2016 Federal Funds Rate 3.25% .38%

10-year Treasury 4.25% 1.50%

Prime Lending Rate 6.25% 3.50%


1. Citizens Financial Group – Net Interest Income Adjustment 1) INTEREST RATE SENSITIVITY DISCLOSURE - The table below displays

the estimated impact on net interest income 12 months out given a 200bp gradual increase in interest rates as of March 31, 2016.

Change in Interest Rates % Change in Net Interest

Income +200bps + 6.9%

Net Interest Margin History (2003-2007)

2003 2004 2005 2006 2007 5-Year Average

NIM


Normalized Profit Adjustments 1. Net Interest Income adjustment

Baseline Q1:16 Net Interest Income = 904 million Annualize the Number = 366 /91 x $904 = $3,636 million Rate sensitivity disclosure +200bps = + 251 million 6.9% increase in NII ----------------------- $3,887 million Post Adjustment Net Interest Margin = 3.08% - up 22bps vs. reported NIM of 2.86% in Q1:16.


2. Citizens Financial Group - Loan Quality Data

2. Net Charge-Off History (2003-2007)

2003 2004 2005 2006 2007 Average Net Charge-Offs/Average Loans


Normalized Profit Adjustments 2. Provision adjustment

Q1:16 Net Charge-offs / Average Loans = 83mm / $100,262 mm = 33bps Q1:16 Provision / Average Loans = 91mm / $100,262 mm = 36bps Baseline Q1:16 Provision for loan losses = 91 million Annualize the Number = 4 X 91mm = 364 million @ .40% of Average Loans = 401 mm - so incremental $ 37 million @ .50% of Average Loans = 501 mm – so incremental $137 million


3. Citizens Financial Group – Efficiency Data

3) Efficiency Ratio History (2003-2007) *adjusted for securities transactions & non-recurring items

2003 2004 2005 2006 2007 Average Efficiency Ratio


Normalized Profit Adjustments

($millions) Baseline Recurring

+200bps yields $62mm/qtr in NII

TopII Efficiency Initiative $20mm/qtr

Q1:16 Pro-forma quarter Proforma Quarter

Net Interest Income 904 966 966 Fee Income 330 330 330 Adj: Securties gains (9) (9) (9)

Non-recurring gains - -

Adjusted Fee Income 321 321 321 Adjusted Total Revenue 1,225 1,287 1,287

Operating Expenses 811 811 791 Non-recurring expenses 0 0 0 Adjusted Operating Expenses 811 811 791 Expense Initiative

Adjusted Efficiency Ratio 66.2% 63.0% 61.5% yields 150bps

IMPROVED INTEREST RATE ENVIRONMENT WILL HELP EFFICIENCY RATIO BY 280bps. of improvement

3. Efficiency/ Expense adjustments


Normalized Profit Adjustments 4. Excess Capital Deployment -

Tangible Common Equity $13,333 million Tangible Total Assets $133,198 million Tangible Common Equity Ratio = 10.0% Judgment call: Assumption here is that capital above 9% TCE is excess capital or about $1.3 billion in excess capital. You can choose to be more conservative.

Opportunity cost of investing capital: Reduce earnings by this amount: EX: Amount of buyback = 1,300 million @ 2.0% = $26.0 million pretax; = $16.9 million after-tax.


CFG - Putting It All Together ($Millions)

Pre-Adjustments Ex-Non-recurring

After P&L Adjustments

Net Interest Income $ 3,636 +251 $3,887

Provision for loan losses 364 +137 501

Net after Provision 3,272 +114 3,386

Fee Income 1,284 1,284

Operating Expenses 3,244 -80 3,164

Pretax 1,312 +194 1,506

Taxes 33% 33%

Net Income 879 +130 1,009

Preferred Dividends 28 28

Net Avail to Common $ 851 +130 981

Average fd shares 530 530

Earnings per share $1.61/share $1.85/share +16%

Avg Assets /Avg TCE $138,780 / $13,169 $138,780 / $13,169

ROA / ROTCE .61% / 6.5% .70% / 7.5%


CFG - Putting It All Together ($Millions) Pre-Adjustments Ex Non-recurring

After Adjustments After Capital Deployment

Net Interest Income $3,636 +251 $3,887 $ 3,861

Provision for loan losses 364 +137 501 501

Net after Provision 3,272 +114 3,386 3,360

Fee Income 1,284 1,284 1,284

Operating Expenses 3,244 -80 3,164 3,164

Pretax 1,312 +194 1,506 1,480

Taxes 33% 33% 33%

Net Income 879 +130 1,009 992

Preferred Dividends 28 28 28

Net Avail to Common $ 851 +130 981 964

Buyback $1.3B @ $22 or 59 million shares

Average fd shares 530 530 471

Earnings per share $1.61/share $1.85/share +16% $2.05/share +27%

Avg Assets / Average TCE 138,780 / $13,169 $138,780 / $13,169 $138,780 / $11,869

ROA/ ROTCE .61% / 6.5% .70% / 7.5% .70% / 8.1%


Advanced Financial Statement Analysis

Denis Laplante July 28, 2016 [email protected]

mailto:[email protected]

advanced denis laplante july 28, 2016 bank analysis with ... · carrying value of non-performing...

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