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Evaluating Financial Institution Financial Condition NCLGIA Summer Conference 2014 The NC Capital Management Trust K. Lee Carter Gary Porter. Background. Government is making a loan to the depository Insurance and collateralization are backup systems See discussion from Policies Manual
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Evaluating Financial Institution Financial ConditionNCLGIA Summer Conference 2014The NC Capital Management TrustK. Lee CarterGary Porter
Background • Government is making a loan to the depository • Insurance and collateralization are backup systems • See discussion from Policies Manual • Some risks of under-collateralization (although slight) • Reputational risk • May take time to fully recover insured and collateralized funds – government may have liquidity problems • Make sure that accounts are coded as public funds accounts • No brokered deposits • File INV-91
Background (cont.) • Government should select a sound financial institution as a depository • Should be evaluated during selection process • Ongoing evaluation of financial condition required • Note: see slide on continuous monitoring
Department of State Treasurer – Policy Manual for Local Governments Section 30: Cash and Investments Part II – Procurement of Banking Services b. Financial Criteria Periodically, concern is raised by units of government concerning the financial soundness of banks and savings institutions. This concern may arise because of changes in economic conditions or from unsound banking practices. It is important that the units assess the financial strength of the institutions with which they regularly transact business. To that end, the staff of the Department of State Treasurer has outlined various methods of analysis to help units obtain a better understanding of the financial position of banks and savings institutions. The areas that will be covered are merely guidelines and do not represent an all-inclusive analysis of a particular institution. These are presented in Exhibit D – Guidelines for Evaluation of the Soundness of a Financial Institution.
Department of State Treasurer – Policy Manual for Local Governments Section 30: Cash and Investments Part II – Procurement of Banking Services One may ask why a financial institution should be analyzed if the local government is properly insured or collateralized with respect to its deposits and investments. The staff of the Department of State Treasurer strongly urges units to place the soundness of a financial institution ahead of collateralization or insurance. Even when deposits of a unit are adequately protected by insurance or collateralization, a significant amount of time may be required before public funds are completely recovered; consequently, a unit may have liquidity problems if it needs immediate access to funds. This means that first level of protection for having funds available when needed is to place public funds only with financially-sound institutions. A unit is making a loan to a financial institution when it deposits funds and should ensure that all financial institutions utilized are financially sound.
Department of State Treasurer – Policy Manual for Local Governments Section 30: Cash and Investments Part II – Procurement of Banking Services 6. Continuous Monitoring of Safety and Soundness of Financial Partners After a bank is selected, the contract awarded and transition completed, it is important to continue to monitor both performance under the terms of the contract and the safety and soundness of banks and other financial institutions transacting business with the unit. An evaluation of the financial condition should be performed no less frequently than annually and quarterly evaluation is encouraged.
Sources of Information • FDIC (fdic.gov) – for individual credit analysis • Can access Uniform Bank Performance Reports from the Federal Financial Institutions Examinations Council (www.ffiec.gov) • Comptroller of the Currency, NC Commissioner of Banks, etc. • Rating agencies (Moody’s, S&P, Fitch) • Independent agencies • Bauer Financial • Star ratings • Bank Rate.com • Star ratings • Financial statement statistics • See Policies Manual for contact information
LGC’s Recommended Objectives Capital adequacy Earnings Problem loan experience Liquidity Look at trend analysis over a multi-year period
Trend Analysis Growth in equity (hopefully from profit) Earnings growth Growth in problem loans Asset Growth
Ratio Analysis • Capital Adequacy – Banks are highly levered • Tier One Risk-Based Capital to Risk-Weighted Assets① • Adequately-capitalized - >= 6% • Well-capitalized - >=8% • Total Risk-Based Capital to Risk-Weighted Assets② • Adequately-capitalized - >= 8% • Well-capitalized - >=10% • Tier One Leverage Ratio③ • Adequately-capitalized - >=4% • Well-capitalized - >=5% • Common Equity Tier One Risk-Based Capital Ratio • Adequately-capitalized - >=4.5% • Well-capitalized - >= 6.5% • Cash Dividends to Net Income – Dividend Payout Ratio④
Ratio Analysis(cont.) • Profitability • Net Interest Margin as Percent of Average Assets⑤ • Net Operating Income as Percent of Average Assets (1%)⑥ • Earnings Assets as Percent of Average Assets (>90%)⑦ • Asset and Earnings Quality • Non-current Loans to Total Loans (~.5%)⑧ • Provision for Loan Losses as Percent of Average Assets (<.5%)⑨ • Allowance for Loan Losses as Percent of Total Loans (1.25%-1.5%)⑩ • Liquidity • Net Non-Core Fund Dependence (~25%)⑪ • Net Loans and Leases to Assets (70%-75%, should not exceed 80%)⑫
Net Interest Margins by Bank Size Source: BankRegData.com
