ROE and Residual income analysis for a bank (Old line Bancshares, Inc.)

Bank Name: Old line Bancshares, Inc.

Question 1.

Table 1. Necessary information¹ to calculate decomposed ROE for Old line Bancshares bank

for last 3 years, as of and for the Year Ended December 31.

			2016			2015			2014
	Average assets		1584,939759			1324,556962			1182,166667
	Average stockholders’	148,9807475			138,7798408			130,146789
	equity
	Net income		13,16			10,46			7,09
	Sales*	68,721			58,298			51,56

Sales are taken as a sum of Interest income and other income, that is to say, total income *.

Other needed information is taken from Income statement and balance sheet of the bank and

the source is represented by a link on the bottom of the page.

Table 2. Components of decomposed ROE

	2016	2015	2014
Profit Margin	0,1914262	0,179492	0,137568
Asset turnover	0,04335875	0,044013	0,043615
Equity Multiplier	10,6385542	9,544304	9,083333

Profit Margin is calculated as a ratio of NI to Sales

1.           https://www.sec.gov/Archives/edgar/data/1253317/000155837017001830/olbk-20161231x10k.htm

Asset Turnover is calculated as a ratio of Sales to Average Assets*

Equity Multiplier is calculated as ratio of Average Assets to Average equity

*Average assets are calculated by summing beginning asset balance to ending and dividing to two.

Table 3. ROE and ROA calculated for each year

		2016			2015			2014
ROE		8,83%			7,54%			5,45%
ROA	0,83%			0,79%				0,60%

ROA is calculated by multiplying all components of ROE from Table 2 and ROA is calculated by multiplying Profit Margin to Asset turnover.

Question 2

1. Profit margin increases on average 2,6% each year which is a good increase as it is around 17% improvement of initial estimate. But we can notice that the increase was more dramatic from 2014 to 2015. It worth to discuss from where this increase comes, to understand  lets discuss net income change and revenue change. From there we can see that first year sales increased by 13% in second by 18% but Net income had exceeding increase 25% and 47%. This speaks that bank improved its operations as the increase of Profit margin is not because of exceeding decrease of sales to Net Income. From balance sheet we can see that this performance is driven by better Interest income and noninterest income performance and also less loan loss provision contributed to profit margin increase. This means relation between deposit interest expense and loan interest rates and durations are improved bank also puts significant attention on non-interest income.

2. We can see that banks asset productivity increased first year than it dropped slightly. At first it increased by 0,03% and than decreased by 0,07% and it has similar estimate in 2016 as it was in 2014. As sales and Income also is increasing this can be because of investments in new assets

and asset increase overcomes sells increase but this condition most probably will change if the bank will be able to gain sustainable share in the market as it has necessary assets to do that.

3.     Equity multiplier increased by 5% in a first year than by 11%. This is a signal of taking more leverage as if EM increases the company is increasing its financing more by debt. Anyway 10,6 is not that big number for this kind of bank but it shows how bank tries to compensate its poor asset performance in order to increase ROE by force of leverage. As debt is cheaper than equity because of it tax allowable expenses and less risk for debtholder. But leverage increase overall financial risk of a bank so, the bank should pay attention on it.

4.   ROA has increasing trend with a time but as we saw above asset productivity is not always increasing, this means that increase in ROA is because of improved cost structure as if revenue increased less than average assets but ROA (NI/Average asset) increased. So, net Income increased not parallel to revenue but overcame it due to improved cost structure.

5.   ROE has increasing trend as well, this is mainly because of improved NI estimate and also change in financing structure, going more to debt financing.

All information to answer this question is taken from IS and Balance Sheet of the bank from  www.sec.gov

Question 3.

Table 4². Peer group companies the source is Google Finance and there were also 3 companies with missing information, so I did not include them.

	Column1			ROE				ROA			Operating			Equity
											Margin			Multiplier*
	SASR			9,12%				0,99%			35,89%			9,21
	HBMD		6,18%				0,54%			16,83%			11,44
	TCFC			7,18%				0,59%			27,15%			12,17
	TYCB		5,34%				0,93%			41,37%			5,74
	GLBZ			3,24%				0,28%			7,96%			11,57

FUNC	5,70%	0,55%	19,25%	10,36
SHBI	6,40%	0,84%	28,96%	7,62
OLBK	8,83%	0,83%	32,63%	9,08
AVERAGE	6,17%	0,67%	25,34%	9,73

https://finance.google.com/finance?q=NASDAQ:OLBK ²

  https://finance.google.com/finance?q=NASDAQ:OLBK

EM* is calculated by dividing ROE to ROA as there was no available information in Google finance.

With green, I mentioned highest measures and we can see Old Line is not a leader in any of them. Source is google finance, which is provided with a link above.

Question 4.

Comparing bank with its peer group we can see that Old line Bancshares operates very well, it has higher ROE, ROA and operating profit. And also we can see that leverage is a little bit less than the average which is a good sign as the higher ROE is because of more efficient operations and acceptable level of leverage. As I mentioned above the company also can improve its asset productivity compared with its previous performance. Moreover, bank has an opportunity also to use leverage to increase its ROE but current structure is quite normal, in conclusion we can say that company operates good enough.

Question 5.

To calculate EVA we need to calculate NOPAT than cost of equity. So, I will start from NOPAT calculation.

Table 5. NOPAT calculation
		2016	2015	2014
Net Interest income		52940	46589	41703
(Actual loan chargeoff)		-1633	-1574	-3438
Non-interest income		8256	6845	5957
(Non-interest expense)		-39643	-36273	-35046
(Income Tax)		-6772,8	-5299,58	-3119,84
NOPAT		13147,2	10287,42	6056,16

Source is  www.sec.gov IS of the bank

Actual loan charge offs are calculated by using given ratios of Non-performing loans to allowance for loan losses and they are more every year then the companies provisions that is why NOPAT is less than Net Income given in balance sheet. Also I took a 34% tax rate and calculated income tax for new level of income before tax.

Now let’s calculate cost of equity using CAMP equation which is equal to RFR+Betta*MP

Table 6. Cost of Equity
		2016			2015			2014
Risk free Rate *		0,32%			0,05%			0,03%
Market premium	11,96%-0,32%			1,38%-0,05%			13,69%-0,03%
Banks betta		0,27
RR (RFR+Betta*MP)	3,5%			0,4%			3,7%

*RFR is taken 3 month US treasury bill rate, source is ycharts.com, betta is taken from google

finance, market return is S&P 500 return from ycharts.com

Cost of equity is calculated as a multiple of total equity for a years and Required Return on

equity.

		2016			2015			2014
Capital beginning		143989			135264			126249
balance
Cost of Equity	5110,46			571,63			4704,42
EVA (NOPAT-Cost of E		8036,74			9715,79			1351,74

Cappital beginning balance is taken from www.sec.gov.

Question 6.

Table 8. ROE and EVA/Beg. Cap compareation

	2016	2015	2014
ROE	8,83%	7,54%	5,45%
EVA/beginning	5,5%	7%	1%
capital

Now we have all information to compare ROE to EVA and to do that we divide EVA to beginning capital to get ratio estimate. We can see in all years ROE is higher than EVA/BC which is because NI in the ROE denominator is always higher than NOPAT-cost of equity as loan provisions are less than actual charge offs and opportunity costs (Cost of equity) is taken into account.

From the table 8 we can see that in all 3 years the bank crated Economic value for its shareholders so it has a good performance. And also we should mention that ROE in 2015 is less than in 2016 but it is vice versa for EVA/BC ratio which is because of little market return in 2015 and as a sequence little cost of equity.

In conclusion, we can surely say that bank performs well enough but also it has a room for improvement particularly in to increase asset efficiency.