Evaluating Financial Performance of Companies - Research Proposal Example

Dissertation proposal: To Evaluate Financial Performance of Companies By SID: Number Faculty Dissertation supervisor: Module leader: 6 April 2015 TABLE OF CONTENT I. INTRODUCTION…………………………………………………………………..3 II. RESEARCH QUESTION AND OBJECTIVE……………………………………..4 III. LITERATURE REVIEW…………………………………………………………...4 IV. METHODOLOGY…………………………………………………………………12 1. Data collection……………………………………………………………………...12 2. Sample of study…………………………………………………………………….12 3. Limitations of study………………………………………………………………...13 V. EXPECTED FINDINGS……………………………………………………………13 REFERENCE………………………………………………………………………………..14 I. INTRODUCTION It is common knowledge that the financial stability and health of the bank has become a certain guarantee for the economy in general as well as for the people who make deposits or shareholders or employees. Thus in recent years a number of measures have been taken in order to evaluate the financial situation of each bank regardless of the size, history or popularity. As a matter of fact in modern world banking and financial industry show the real face of economy and we can witness a considerable growth both in quantity of banks and the amount of money being managed by. The purpose of this study is to show that despite of the visible success there are still challenges to be faced and much effort to be taken in order to supervise and give professional assessment of the institution in question. The main ail of the steps to be taken is the increase of quantity and quality of the services and walking hand-in-hand with the developments that take place every day. Banks in United States are presented in a field of private business and their job is to obtain capital and to do so the bank must not display excessive risk or inadequate profits and this is sure to erode the overall success of the institution. People are interested in high quality of bank’s performance whether they are stakeholders or depositors as stockholders are initially concerned with profitability of the bank because the main factor defining their total return as a result of holding bank stock, at the same time huge corporate depositors and examiners who represent the regulative organ are concentrated on exposure of risks of the bank. The financial statement of the bank can be determined as measurement of its failure or success in terms of money. The assessment of the financial performance can be exercised through a number of key descriptive and analytical measurements. Descriptive measures involve total assets, liabilities, equity, expenses and revenues and net income while analytical indicators of financial performance imply profit-ability, efficiency, liquidity and solvency measures. The reason of picking this topic for research is that banks have been a part of everyday life for thousands of years and the audience including stakeholders, corporations or citizens is sure to be interested in financial performance of the bank to ensure themselves with safety and confidence in long-term cooperation. II. RESEARCH QUESTION AND OBJECTIVE Title of the dissertation: To Evaluate Financial Performance of Companies. Research question: What are the measurements and methods to evaluate the financial progress of the bank in the most effective way and what ratios influence the overall performance? Research objectives: - This paper seeks to describe the importance of the evaluation of financial performance of banks as a way to improve the accountability power, taking into account Security Pacific Bank experience as the sample. - To discover what analytical and descriptive tools should be applied to a financial statements of the bank in order identify problems within each bank and find ways for these problems to be solved in the most effective way. III. LITERATURE REVIEW A review of literature is meant to help the researcher to draw the outline of the present conditions of the topic of the study. The survey of the literature is to depict the work that has already been done about this very topic as well as questions never touched and draw the future researches to be done. The material for this research includes information on national and international level, academic articles and books giving professional opinion and experience to be used. There is a firm belief that generally on-site examination and assessment of the bank has been the basis of the supervisory process taking place both state and Federal level. This complex process implies the regularity of the visits on the bank of interest with conduction of interviews with management side as well as the evaluation of the financial statements and their accuracy, accounting sheets and the law and regulations fulfillment. The on-site inspection gives a chance to supervising board to assign the rating for the bank being supervised on the basis of the information from the findings collected in the inspection process. The rating is basically a result of the CAMELS rating method that is widely used and is considered to be effective tool in evaluation measurements. The market of finance is a living organism that undergoes everyday changes an thus a precise examination of this field is an expected phenomena, its importance cannot be overestimated and it is to be conducted more frequently. As a result the examiners tend to rely on the off-site surveillance as the source of updated relevant information on financial performance as serves as the spine for evaluation of the bank between the on-site examinations. Off-site information serves to draw the light on to the risks taking into consideration the annual or quarterly statements and accounts, and it helps the examination board to schedule the examination process on the suspicious banks. The advantages of the off-site surveillance include lower cost in comparison with the on-site surveillance and the ability to supplement the information with updated data based on quarterly statements more frequently. It is the fundamental of the assessment of the financial performance when the examinations are not given. As a sample of my research I have taken Security Pacific Bank as an example of unsatisfactory performance and the main ail of this study is to trace the main causes of this situation as a result of overall performance evaluation. SPB, initially named Golden Pacific Bank, insured by the FDIC and was founded on December 7, 1981. The name of the institution was changed to Network Bank USA in 1999 and finally became SPB in 2004 which was headquartered in Los Angeles, California. This particular bank had four branches in California, it provided traditional banking services within market and was basically concentrated on commercial real estate (CRE), and specialized in residential acquisition, development and construction (ADC) loans which were significantly concentrated in the areas of Southern California. In order to look at the real state of this bank’s performance an interested person must take a look at the key figures of taken from accounting records. The examiners of the financial institutions use the Uniform Financial Institutions Rating System (UFIRS) as a tool of evaluation of financial conditions of the bank in components which are represented by the CAMELS acronym: Capital adequacy, Asset quality, Management practices, Earnings performance, Liquidity position, and Sensitivity to market risk. Figure 1 gives an overall analysis on each of the component. Looking at this table we can see that each component is assigned a rating of 1 to 5 in accordance with the least and the greatest regulatory concern. Detailed information on SPB’s financial condition in 5 calendar years period of 2008-2013 is followed in Table 1. Brief outline of the results: The primary reason of SPB failure is in bank management’s pursuing a high-risk strategy of business concentrated on rapid growth of asset. As the market of the residential real estate of California underwent reduction in 2007, the loan portfolio of SPB worsened very rapidly and damaged the financial performance of the institution. Eventually, experiencing continuous loan losses, the institution was no longer able to maintain adequate profitability or satisfy the requirements of liquidity which resulted in its failure. Using the CAMEL method of assessment and taking into consideration components if this method we can retrieve data and analyze what specifically ratios and indicators had gone through dramatic changes. Management The board of directors of SPB failed to make sure that management of the institution took steps to identify, assess and take under control the institution’s activities risk or react immediately with corrective actions as a sound response to the recommendations of the examiners. More specifically, the board of directors did not ensure that the appropriate controls were on their places such as those related to concentrations, underwriting of loans, administration of credit, take proper actions in order to manage the rapid growth in portfolio of loan. In addition to previous problems, SPB did not fulfill the recommendations in Federal Deposit Insurance Corporation and examination reports of the Department of Financial Institutions referred to diversification of the loan portfolio, insufficient real estate lending monitoring and liquidity management. Even further, the board of examiners fairly criticized both market analysis management and monitoring processes, taking into consideration that the bank failed to take adequate and appropriate action to resolve the problems connected to the residential real estate market in 2007. Table 2: SPB’s Asset Classifications and Allowance for Loan and Lease Losses (ALLL) Asset Quality During the period of 2004-2006 SPB’s asset quality received a satisfactory rate after examinations had been given. But further examination that took place a year after in 2007 showed that conditions had worsened, and this was evidence that the level ob bank’s risk along with problem assets were serious with no adequate control upon them accompanied by forecasted potential losses were as a main threat to bank’s viability. In 2008 the bank ratios were estimated as critical. SPB’s asset quality worsened as asset classifications dramatically increased from $11,000 in 2004 to over $132.5 million which is over 27 percent of a total loan portfolio as of 2008. And during 2004 examination process, the disadvantageously classified items were 0.04 percent of Tier 1 Capital plus the Allowance for loan and lease losses. As a result of evaluation of 2008, this ratio rose to 198.72 percent of Tier 1 Capital plus the Allowance for loan and lease losses. Liquidity Security Pacific Bank resulted in dependency on higher-cost and more unstable commercial funding sources, for example Internet certificates of deposit (CD), Federal Home Loan Bank (FHLB) promotion, and money desk deposits in order to fund asset increase. The level of liquidity decreased due to the fact that management failed to monitor properly and control ratios of liquidity or apply timely an appropriate liquidity plan within these circumstances. To be more specific, management was not able to reduce to eliminate the level of dependence on non-core deposits on time. Table 3: Examiner Comments and Recommendations Regarding SPB’s Asset Quality Table 5: Examiner Comments and Recommendations Regarding SPB’s Liquidity   SPB required appropriate controls of liquidity management that involved detailed Contingency liquidity plan (CLP). Consequently, due to malfunction of management and failure in implementing sound measurements in liquidity controls along with increasing risk level in 2008 the overall position of SPB turned to severely critical thus making the institution dramatically unprofitable. IV. METHODOLOGY Methodology section serves as a guideline for the research route to be followed, giving the detailed description of the instruments to be used while working on research, data collection from the sample of the study being chosen, the tools and methods used to analyze the topic and path to the conclusion and findings to be deduced. Main method to be used in this particular research in order to make a sound assessment of the financial performance and to draw a realistic portrait of the bank’s situation is called CAMELS method. This acronym includes six factors which are used in international bank-rating practice. CAMELS parameters are: C - Capital adequacy A - Asset quality M - Management quality E - Earnings L - Liquidity S - Sensitivity to Market Risk 1. Data collection For this particular work the researcher has used the secondary data which is presented in key facts and figures, account records serving as a relevant source of information taken from articles, audits and other internet resources. This type of collecting data is no less useful as the primary data and it is meant to prove useful when giving a response to the questions of the research. Working on this study, annual reports of the Security Pacific Bank were used as a source of secondary information aiming to collect reliable and relevant data on general aspects and ratios to measure levels of assets, risk and efficiency. 2. Sample of the study The topic of this research played a great role in making choice of the sample of the study. The SPB’s tragic experience is to show the importance of evaluation processes of the financial industry institutions as they help the bank to assess risks and losses, giving sound regulations and recommendations to be followed timely for excellent financial performance. 3. Limitations of the Study. While working on this study researcher faced following limitations: Due to territorial and time boundaries the primary data collection such as interviews of SPB employees could not be fulfilled which might have given more detailed and diversified information to form the overall analysis of the situation and to understand the financial performance better. As the study is based on Secondary information only the relevance and accuracy of this research depends on relevance and accuracy of the information used. V. EXPECTED FINDINGS Banks have always been a great part of social life of people tracing their history back to primitive currency operations till nowadays. Bank supervision is a fundamental of a sound financial performance and as a result an indicator of a healthy economic situation of the country. According to the fact that the market of finance has changed over years there is vital importance of examination programs both on-site and off-site where CAMELS evaluation method plays a great role in supervision which can hardly be overestimated. While working on this topic the researcher concentrated on two aspects to approach this topic: CAMELS parameters as the tool in supervision of financial sphere institutions. The practical section of the research was dedicated to analyzing Security Pacific Bank’s overall performance. The findings approved that the CAMELS rating system plays a crucial role in banking performance supervision, it is widely used due to its effectiveness and international approach and it makes on-site and off-site examinations more flexible. Though the evaluation programs and objectives may differ in companies, banks and parts of the world the scope of the study was to reveal the efficiency and effectiveness of the method. A non-profitable bank was chosen to display the importance of evaluation process as well as fulfillment of professional recommendations and implementing adequate measurements on time. In addition future researchers might get interested in bank’s evaluation examinations that played a dramatic role in the life of the institutions tracing the long way from the birth to death of the bank in order to point out the mistakes and learn the lessons as Bram Stoker once said: we learn from failure, not from success. REFERENCE Methods of Bank Performance Evaluation. 2015. Methods of Bank Performance Evaluation. [ONLIN Available at: http://www.slideshare.net/nehaa299/methods-of-bank-performance- evaluation. [Accessed 03 April 2015] Tabassum, N. (2015) available from [ Accessed 3 April 2015] Adam, M. (2015) Evaluating The Financial Performance Of Banks Using Financial Ratios [online] available from [3 April 2015] Alam, T. (2015) An Evaluation Of Financial Performance Of Private Commercial Banks [online] available from [3 April 2015] Investopedia, (2003) CAMELS Rating System Definition | Investopedia [online] available from [3 April 2015] Dang, U. (2015) The CAMEL Rating System In Banking Supervision [online] available from [3 April 2015] Ravinder, (2015) A Camel Model Analysis Of Nationalized Banks In India [online] available from [3 April 2015] Fdicoig.gov, (2015) FDIC OIG Audit Report: Material Loss Review Of Security Pacific Bank, Los Angeles, California, Report No. AUD-09-012, May 2009 [online] available from [3 April 2015] Read More