Financial Performance Issues - Essay Example

CASE ANALYSIS: SHENZHEN DEVELOPMENT BANK By Student’s Name Code + Course Name Professor’s Name University Cite, State Date 1. SDB’s Financial Performance In 2002, SDB’s Non-performing loans ratio stood at 11.6%, which was a drop from 15.3% in the previous financial year. On the other hand, the industry average NPL ratio stood at 7.3% within the same financial year. This is an indication that although SDB had made stringent efforts to lower its ratio it still stood way above the overall industry average (Marshall, McManus and Viele, 2008). The firm’s relatively higher NPL ratio postulates that it suffers from poor quality loan portfolio in comparison to the industry averages. SDB’s immediate loan loss reserve ratio stood at 3.9% in 2002 against a 3.8% ratio value of the overall industry average. This ratio is also way above the recommended LLR ratio of the company that is placed at 1%. This rather high ratio postulates that SDB is likely to suffer higher loan provisions or rather credit costs, which have a direct effect on the income statement of the bank given that it reduces the level of operating profits. Due to the possible reduction in the operating profitability of the firm, the bank cannot be able to generate enough internal capital that is greatly needed to strengthen its balance sheets. Thus, it would lead the bank to source for external sources of new capital in order to maintain a sustainable capital adequacy platform that is recommended by the regulators (Benninga and Oded, 1997). Earnings Capability Some of the notable time trends of SB’s key earnings measures are discussed as below; First, the bank’s net interest margin is placed at 3.5% in 2000 which then drops to 2.8% in 2001 before dropping even further to 2.4% in 2002. Despite the drop of the ratio within the three financial years, it can be clearly seen that they are fairly placed above the industry average ratio of 2.3%. This is a positive indication since it postulates that the bank had made significantly optimal decisions that facilitated the reduction of the interest expenses of the bank visa-vie its immediate returns that were yielded by the investments made within the period (Marshall, McManus and Viele, 2008). Second, the bank’s non-interest income/operating income ratio increases significantly from 3.4% in 2000 to 6.5% in the financial year ending 2001 before jumping upwards to a whopping 9.5% in the financial year ending 2002. In 2002, the ratio stood way above the industry average that was placed at 8.4%. This rather highly placed ratio is an indication that Shenzhen Development Bank is able to generate sufficient income from such activities involving transaction fees, monthly account maintenance charges as well as transaction fees. It also means that the bank’s larger size of income is mostly from the non-interest income as opposed to the operating income. This ensures that it enjoys greater liquidity position in case there are numerous cases of booming loan default rates (Fisher, Heinkel and Zechner, 1989). Third, Shenzhen Development Bank’s operating expense/operating income ratio is placed at 65.6% in 2000 that remains relatively constant in the financial year of 2001 before decreasing insignificantly to 58.3% in the financial year ending 2002. In 2002, the ratio stood way above the recommended industry average of 55.3%. Despite the efforts of the bank to decrease the ratio, it still postulates a rather unhealthy status of the bank given that the its operating expenses have far much exceeded the level of operating income posted within each given year. The increase in ratio might be attributed to higher administration expenses as well as relatively higher wages and salaries offered to the rather exceeding higher level of employee personnel (Marshall, McManus and Viele, 2008). Fourth, Shenzhen Development Bank’s return on assets (ROA) ratio is placed at 0.9% in 2000 which then drops significantly to 0.4% in 2001 before decreasing again to 0.3% in 2002. In 2002, the ratio stood way below the recommended industry average ratio of 0.6%. This postulates a rather unhealthy profitability phenomenon given that the bank is not able to generate sufficient revenues for each dollar of assets investment made to the bank. This might be attributed solely to failure of the bank’s immediate personnel to utilize existing asset portfolios to conduct sufficient business transactions that in turn translates to possible accumulation of gross revenues needed for catapulting profits. Fifth, Shenzhen Development Bank’s return on equity (ROE) ratio is placed at 22.4% in the financial year ending 2000 before decreasing significantly to 9.4% in 2001 and a later decrease to 9.1% in the financial ending 2002. In 2002, the bank’s ROE ratio stood way below that of the industry average that was placed at 26.8%. The lowly placed bank ratio postulated unhealthy profitability earnings given that shareholders were not getting sufficient level of returns for the level of investments made within that particular period. It could also mean that the bank was operating under bank deposit financial structure rather than under the shareholder’s equity structure to generate businesses (Marshall, McManus and Viele, 2008). Capital Adequacy The bank’s Tier 1 CAR stands at 5.2% in the financial year ending 2002. This ratio stands below the industry average of 6.0%. This is an indication that the firm’s retained earnings could substantially provide a significant base for capital adequacy requirements. The bank’s Total CAR reduces significantly from 10.6% to 9.5% in the periods between 2001 and 2002. This ratio is placed above the industry average of 8.8%. This highly placed ratio is an indication that the bank is able to protect depositors’ money as well as enhance stability and efficiency of its financial systems (Marshall, McManus and Viele, 2008). This favorable phenomenon might be attributed to it being a majorly state-owned bank that operates under state-council regulations. The firm’s equity-to-gross loans ratio decreases significantly in the three year periods from 10.7% in 2000 to 7.9% in 2001 before dropping further to 5.1% in 2002. This ratio stands above the industry average of 4.9%, which is an indication that the firm’s private equity base is far much strengthened and recommended (Marshall, McManus and Viele, 2008). The bank’s equity-to-total assets ratio also decreases from 6.2% to 3.5% in the period between 2000 and 2001 and later drops to 2.6% in the year 2002. This ratio stands below the industry average of 2.7%, which is an indication that the firm’s private equities exceed the risk weighted assets value (Marshall, McManus and Viele, 2008). In my opinion, the valuation of 16 times book value that Newbridge purports to pay is considerable and appropriate. This is mainly because it will be able to utilize its controlling stake of the firm to improve on the already tainted poor governance structures and also, come up with profitable loan policies. Right now, almost most of the state-owned banks as well as foreign investors are allowed to make investments regardless of the existing demographics thus, these banks operate on an even platform that of catapulted by positive governance might trigger higher performance levels (Graham, 2000). Consequently, the Chinese banking sector is performing fairly well while there is still room for improvements. References List Benninga, S, and Oded S, 1997, Corporate Finance: A Valuation Approach, McGraw-Hill, New York Fisher, E, Heinkel, R and Zechner, J. 1989, Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19–40 Graham, R, J.2000. How big are the tax benefits of debt? The Journal of Finance, vol.LV, no.5: pp 1901-1942. Marshall, DH, McManus, WW& Viele, DF, (2008). Accounting: what the numbers mean, 8th Ed. McGraw-Hill/Irwin, New-York. Read More