Asset/Liability Management Presented to the Junior Class North Carolina School of Banking Presented By Harry M. Davis, Ph.D davishm@appstate.edu NCBA Professor of Banking and Economist Appalachian State University August 2019

Sample U.S. Commercial Banks With Assets $100M to $1Billion Table II Sample U.S. Commercial Banks With Assets $100M to $1Billion Year End, 2018 Data, (000s) $100Million to $1Billion $1Billion to $10 Billion Risk-Adjusted NIM 3.68% 3.51% Net Noninterest Margin(NNIM) -2.12% -1.44% Gain/Loss on Sale 0.07% 0.10% Income Before Tax 1.62% 2.17% Taxes 0.34% 0.82% Net Income (ROA) 1.28% 1.35% Equity Multiplier (EM) 8.77 8.70 ROE 11.24% 11.75% Efficiency Ratio 66.11% 59.00%

Spread Management Analysis Spread Management Analysis (SMA) is a Method of Examining The Strengths And Weaknesses of the Profitability of a Bank Spread Management Analysis Allows Us To Compare Our Performance Through Time Or To That of Our Peers All Items in the Income Statement are Divided by Average Assets or Average Earning Assets This Process Common Sizes Our Income Statement and Allows Us to Compare Our Performance To That of a Peer Group UBPR By the FDIC

Table I Shows an Income Statement and Several Balance Sheet Items For a Sample U.S. Bank With Assets of $100 Million to $1 Billion, Year End, 2018 Table II Shows The SMA Based on the Figures in Table I Figures Are Also Shown For Banks With Assets Between $1 Billion and $10 Billion

SMA Starts By Looking At Interest Income and Interest Expense As a Percent of Average Assets Each Interest Income and Interest Expense Item is Divided By Average Assets of $585,000. We Have Two Interest Income and Two Interest Expense Items.

Table I Shows the Following: Interest on Loans = $19,500 Interest on Investments = $7,000 Dividing Each By $585,000, Table II Shows: $19,500/$585,000 = 3.33% $7,000/$585,000 = 1.20% 3.33% + 1.19% = 4.53% For Interest Expense We Have: $3,100/$585,000 + $800/$585,000 = 0.67%

The NIM Decline 1. Intense pricing competition for both deposits and loans 2. Flatter Yield Curve – Greenspan, Bernanke, Yellen 3. FED cuts/increases result in interest income falling/rising faster than interest expense 4. As NIMs Declined, Loan/Deposit Ratios Increased From 75% to over 90% after 1993 as Banks Attempted to Maintain Profitability L/D ratios dropped with recession but have risen since

The Yield and NIM

SMA Now Examines The Noninterest Income and Noninterest Expense of the Bank TABLE I Shows that Sample Bank has one Noninterest Income Item and three Noninterest Expense Items. The Net of Noninterest Income and Noninterest Expense is the Net Noninterest Margin (NNIM) See Table II

ROE can also be found by multiplying ROA times the Equity Multiplier (EM) ROE = ROA * EM The Equity Multiplier is simply: Average Assets/Average Equity or from Table I $585,000/$66,700 = 8.77

Efficiency Ratio The Efficiency Ratio Measures How Well a Bank Controls Operating Expenses The Ratio is Calculated As Follows: Noninterest Expense/ (Noninterest Income + NII) For Sample Bank We Have: ($11,600 + $5,300 + $3,000)/ ($7,500+ ($19,500 + $7,000 - $3,100 - $800)) = 66.11%

Credit Risk Ratios Assets $100 Million to $1 Billion Year End 2018 Net Charge-offs/Loans and Leases = .15% Loan Loss Allowance/Loans = 1.25%

New Balance Sheet Strategy Is Required Where Are Interest Rates Headed? What Will happen to NIMs if Rates Rise/Fall? Do banks like a normal yield curve? Core Deposits are Very Important to Protect the NIM Rapid decline in the number of small banks Capital Is King!!!! Who has the Currency for M & A Activity?

Community Banks As of the end of the first quarter 2019, there were 5,362 FDIC insured institutions About 3000 Financial Institutions have been absorbed through M&A since 2008 70 Institutions absorbed through M&A activity in the fourth quarter of last year 2 new charters in the fourth quarter “De Novo” Banks are back?

Important Terms 1. Net Interest Margin (NIM) 2. Risk-Adjusted NIM 3. Net Noninterest Margin (NNM) 4. Rate of Return on Assets (ROA) 5. Equity Multiplier (EM) 6. Rate of Return on Equity (ROE) 7. Efficiency Ratio