Nov 19, 2020 in Case Studies

Financial Markets And Institutions Case Study Analysis
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Financial Markets and Institution Case Study Analysis

Banks and financial institutions are intermediaries between the individuals or corporate that borrows or saves money with them. It works this way because the main banking business involves giving out credit facilities to customers and taking their deposits. Banking business is financed by customer loan items to customers and also acquiring loans from other financial markets. Therefore, when the interest earnings curve is normal then the bank considered earning a positive diversification and achieving the loan maturity which is always higher comparing to the deposits. Contrary, when the yield curve is abnormal, the bank considered having a negative diversification; therefore fails to achieve its loan maturity. It means that the deposits are higher than the loans. Banks and financial institutions need to guard themselves against abnormal yield curve by involving in assets and liability management to trade in floating-rate loans.

 

Financial analysts determine the market yield curve of a bank. They take into consideration all bank valuation issues in the market. The bank valuation issues are the metrics that measures competition of a particular bank status along with other banks on the market. Financial analysts and bank rating agencies extract these metrics from the bank financial statements that enable them to test the financial health status of the bank. They extract the bank valuation issues from the information given and use various accounting measures to receive reliable information efficient for analyzing and rating the bank on the financial market. The bank valuation tools extracted include the credit quality, capital, liquidity and profitability. This paper will discuss the bank valuation issues for the Sun Trust Banks Inc and provide a conclusion based on the valuation considerations of the bank.

Sun Trust Bank Inc is Georgia's biggest commercial, and financial institution organizations formed with a major objective to offer a wide range of financial services to individual customers, business firms and corporate. The major products offered are full-time financial services for consumers and businesses including deposits, credit, mortgage banking, trusts, asset management, security brokerages, capital market services and investment services. Sun Trust Bank Inc's financial information is the one to be referred in the discussion regarding bank valuation issues.

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Credit quality is a bank's valuation issue that refers to the quality of the bank loan statement as proved by the borrower's credit worthiness and the geographical distribution of the loans. Therefore, a credit quality has a direct relationship to the loans probability of defaulting. The bank should, therefore, provide, the financial statements, and the provision for probable future losses as this directly affects the future net income flow. It should be noted that if a bank overstates the provision for losses, the net income will be affected, and vice versa. The valuation consideration for this issue is based on when the market of the bank is strong and the credit loss is low, the operating management team is advised to make provisions for a possible market slow down. Banks operating primarily on earnings may not provide future credit loss properly.

Evaluating for the Sun Trust Bank Inc, given the summary for income data for the period ending 31st December 2013:

Example 1: The reserve schedule for losses for Sun Trust Bank Inc

Balance at the end of year 2012: ... $2219

Provision for losses: ... $548

Charge-offs:

Commercial loans (219)

Residential loans (531)

Consumer loans (119)

Total charge-offs: ($869)

Recoveries:

Commercial loans 66

Residential loans 87

Consumer loans 38

Total Recoveries: $191

Net Charge-offs: ($678)

Balance at the end of year 2013: $2094

From the banks reserve schedule above, it can be noticed that the bank has an opening reserve of loan losses of $2294. During the operational year, they gave a provision of $548; however, the net charge-offs are higher than the provisions giving a lower reserve carry forward. The loans reserve to loans ratio has declined by 0.06% compared to the previous year (2294-2094/2294 = 0.06%). If the lower ratio of 0.06% does not reflect a change in the business income, the bank ought to reduce the level of loans in order to catch up with the losses.

 
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Capital as a business valuation issue is the financial tool used to absorb unexpected losses that may arise. Capital in this context refers to the difference between all the banks assets and liabilities. The measure of the valuation for this issue is whether the business is solvent or insolvent. Solvent means that the assets are in excess of the liabilities. There are legal requirements that restrict banks and financial institutions to have a minimum capital reserve. Banks that do not comply to these requirements are supposed to close the doors. The regulations are set by the central bank of every state and the World Bank. The capital bank issue valuation is measured using capital adequacy ratio. Capital adequacy ratio is a unique ratio used by banks and financial institutions to establish the adequacy of their capital reserves taking into consideration their risk exposures. Central Bank and World Bank require every financial market to have a minimum capital adequacy ratio so that they can absorb losses before becoming insolvent. The requirement enhances stability of the banks and financial institutions; therefore, safeguarding the interests of the deposit holders.

The formula for calculating capital adequacy = (Tier 1 capital + Tier 2 capital)/Risk-weighted exposure. Tier 1 capital is a common stock tie for capital whereas risk weighted exposure is the average sum of the banks risk exposure. The capital adequacy ratio for Sun Trust Bank Inc is calculated as:

Tier 1 common equity capital = $14602 million with risk exposure rate of 9.82%

Tier 1 capital = $16073 million with risk exposure rate of 10.81%

Total capital = $19052 million with risk exposure rate of 12.81%

Tier 1 leverage ratio of 9.58%

Capital adequacy ratio = (Tier 1 common equity capital + Tier 1 capital)/risk-weighted exposure

Risk-weighted exposure = 9.58 %*( 14602+16073) = $1501.665

Adequacy ratio = {14602*9.82% + 16073*10.81%/ (1501.665) = $2.112 million.

Liquidity is the measurement of the ability and ease that the bank's asset can be changed to liquid cash. Liquid asset is the asset which can easily be converted to cash in the shortest period, usually, less than a year, in order to meet a financial obligation. The greatest asset for a bank is loan given to client plus other investments. Liability involves customers deposits. Liquidity is evaluated using liquidity ratios. The ratios include the current ratio and the quick ratio. Current ratio is received by dividing total current assets of the bank by its total current liabilities. Determining the liquidity state of Sun Trust Bank Inc, the information from the income statement is used where,

Total current assets = $72, Total Current liabilities = $4

Current ratio = 72/4 = 18

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Therefore, the bank can meet its short-term financial obligation.

Finally, profitability is one the banks valuation issues. Profitability is the ultimate goal of the financial market. Like other business sectors, banking and financial institutions profitability is measured using the income and expenses. Income and expenditure can be found in the reported income statement at the end of the financial period. Profitability is derived by summing up all the interest incomes received from loans and other investments and then deducting the total expenditure to receive net profit before taxation.

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