Keystone National Bank Analyses

This report analyses Keystone National Bank's financial performance, including its relative earnings performance with peers, financial risks, interest-sensitivity, and liquidity needs. Specific recommendations are provided for improving the bank's earnings performance and financial strength.

Running head: KEYSTONE NATIONAL BANK ANALYSES
Keystone National Bank Analyses
Name
Institution

KEYSTONE NATIONAL BANK ANALYSES 2
Introduction
Analysing the financial performance of commercial banks is done to meet the
objectives of respective stakeholders. For instance, bank regulatory is interested in
understanding the financial challenges facing commercial banks and the measures that have
been put in place to counter them. Shareholders use financial performance analysis to
determine whether or not to invest with a bank. Lastly, banks also evaluate their financial
performance to develop sustainability goals and viable management decisions.
This report is divided into five sections. The first section analyses Keystone's relative
earning performance with its peers between 1989 and 1900 using financial profitability
rations. The second section analyses the financial risks undertaken by the bank to attain its
returns. The third section examines the Keystone's interest- sensitivity. The fourth section
evaluates Keystone's liquidity needs over the first quarter of 1991. The fifth section provides
specific recommendations to the management of the Keystone National Bank for improving
the bank's earnings performance and financial strength.
Question 1: Compare the relative earnings performance of Keystone National Bank
with its peers in 1989 and 1990
Earnings are also known as bottom line refers to a company's net income after tax
deduction. Earnings determine a company's profitability and share price. Earnings is a mostly
studied element of financial statements because it shows the profitability performance of a
company relative to its peers in the market or based on the pre-established guidance. The
earning performance of Keystone National Bank is indicated under Exhibit 3 on Key
financial ratios. The key earnings ratios under study are Return on assets, Net profit margin,
Asset yield, Return on equity, and leverage (Bailey, 2005).

KEYSTONE NATIONAL BANK ANALYSES 3
Return on assets (ROA) is a profitability measure used to evaluate a company's net
income generated from its total assets. In a relative analysis between a company and its
competitor(s) in the market, the one with the highest ROA is considered to be more
profitable. Keystone's ROA decreased from 0.95% in 1989 to 0.91% in 1990 compared to the
Peer Group's increase from 1.02% in 1989 to 1.04% in 1990 (Ghosh, 2012).
Net profit margin is a profitability ratio that indicates the percentage of a company's net
profit produced by its revenue during a specific period. Net profit margin ratio is calculated
by dividing the net profit by total revenue then expressing the ratio as a percentage (English,
2011). In a relative analysis between a company and its competitor(s) in the market, the one
with the highest Net profit margin is considered to be more profitable. Keystone's net profit
margin increased from 8.04% in 1989 to 8.36% in 1990 compared to the Peer Group's
increase from 8.80% in 1989 and 9.70% in 1990.
Asset yield indicates the amount of investment income and dividend that a company
yield from investments and loans offered to its customers. The higher the yield on assets, the
larger the income generated from loan and investment options offered to customers (Tracy,
2012). In a relative analysis between a company and its competitor(s), the one with the
highest Net profit margin is considered to be more profitable. Keystone's asset yield
decreased from 11.81% in 1989 to 10.88% in 1990 compared to the Peer Group's decrease
from 11.59% in 1989 to 10.72% in 1990. Generally, Keystone performed better compared to
its peers.
Return on Equity (ROE) is a profitability measure used to evaluate a company's net
income generated from shareholders' equity. In a relative analysis between a company and its
competitor(s) in the market, the one with the highest ROE is considered to be more profitable

KEYSTONE NATIONAL BANK ANALYSES 4
(Tracy, 2012). Keystone's ROE decreased from 14.73% in 1989 to 13.82% in 1990 compared
to the Peer Group's increase from 14.41% in 1989 to 14.90% in 1990.
Leverage/ equity multiplier is a profitability ratio used to calculate a company's
leverage. The ratio is calculated by dividing a company's total assets by its total equity. A
high equity multiplier ratio shows that a company uses more debts compared to equity to
finance its assets (English, 2011). Keystone's equity multiplier decreased from 15.50x in
1989 to 15.20x in 1990 compared to the Peer Group's increase from 14.12x in 1989 to 14.33x
in 1990.
Question 2: Evaluate the financial risks which Keystone National Bank has taken to
attain these returns
Commercial banks are associated with a number of risks. When the value of net leases
and loans is huge compared to core deposits, a bank is considered to have poor utilisation of
resources as well as low liquidity level. Banks consider both consumers and commercial
loans when determining the degree of risks associated with their operations. Banks with high
loan portfolio level is exposed to a high degree of default risks. In 1990, Keystone's loan
portfolio decreased by 10% which reduced its ability to maximise shareholders' equity (Zagst,
2013).
Keystone National Bank held the higher provision for leases and loans when compared
to the peer group. This shows that Keystone had anticipated an increased level of credit risks
which would subsequently increase the degree of loan defaulters. However, the tangible
amounts that the bank charged against the actual defaulted loans were lower compared to that
of its peer group between 1989 and 1990 (Sierra, 2004). The analysis presents Keystone as a
bank with the ability to maintain a low rate of loan default. Keystone uses its excellent ability
to control its loans and leases accounts to improve its capital base and income generation.

KEYSTONE NATIONAL BANK ANALYSES 5
Nevertheless, maintaining higher provisions for losses on loans and leases shows that
Keystone is more likely to incur loan losses compared to its peers which hinder its ability to
effectively increase its capital and net incomes.
Keystone also suffered from liquidity risks. Liquidity examines the ability of an
organisation to meet its short-term obligations using its most liquid financial instruments such
as its current assets. Keystone was faced with the inability to raise adequate funds required to
meet client credit and withdrawal requests as well as other financial needs. Such a situation
would compel Keystone to obtain crisis reserves at a higher cost which reduces its
profitability level. Keystone dealt with the risks associated with its operations effectively
with an objective of meeting its end goals and objectives (Msindo, 2015).
Question 3: Analyse the interest- sensitivity report in Exhibit 4. What are the
shortcomings of the report in revealing Keystone’s interest-rate risk position at the end
of 1990?
Static GAP technique is used to examine changeability of interest rates changed on a
bank's assets and liability within a period of twelve months. Banks experience compression in
net interest margin and reduction of net income when market interest rates keep on changing.
Static GAP refers to the difference between the cumulative sensitive rate of assets and
liabilities during the period (12 months). A larger static gap shows that a bank has been
exposed to interest rate risks. The Keystone National Bank used the interest sensitivity report
for a period of 12 months to establish how changes in the interest rates affect its financial
performance and profitability (Stoica, Nucu, & Diaconasu, 2014).
Banks use a winning spread technique to determine their productivity relative to the
changeability of interest rates. Therefore, the management should establish an effective
spread that sustains an organisation's overall financial performance goals. The administration

KEYSTONE NATIONAL BANK ANALYSES 6
of Keystone has not set out a percentage of profit quantified an acceptable interest charge
over the period. Without establishing an acceptable percentage of chargeable interest rates,
Keystone will become less attractive and with low proficiency. Companies with the ability to
maintain low-interest charges on their assets and liabilities are associated with high
proficiency, high profitability and administration productivity (Gray D., 2012).
The analysis showed that the Keystone extends the maturities of its assets without
doing so on its corresponding liabilities which led to an increase in the interest rate. The
Asset/Liability Management Committee (ALCO) provides tools used to measure exposure
and impact of interest rate risk on banks. Moreover, banks are required to provide sufficient
information used to establish sources of interest rate exposures and noncompliance with
established risk limits. Keystone has not disclosed the information used to arrive at the
interest sensitivity analysis as captured under exhibit 4 (Beccalli & Poli, 2015).
Keystone did not disclose its established risk rate limits which made it difficult to
determine the degree at which the bank's assets and liabilities have been exposed to risks,
noncompliance with the risk limits as well as the impact of the interest rates on the financial
performance. The bank has also not provided a detailed report to the board members with
details of how interest rates would be controlled in the case where rates are higher than the
set limits (Giovanni, 2013).
Keystone National Bank was faced with an unstable interest rate which affected its
ability to fully realize its financial potentials. Changes in interest rates were caused by the
trends in the economic environment. However, the 1990 interest sensitivity analysis report
does not provide detailed information about the exposures and impact of risks arising from
interest rates. Therefore, Keystone should develop an effective interest rate risk management
program (Berger, 2015).

KEYSTONE NATIONAL BANK ANALYSES 7
Using the data in Exhibit 5, determine Keystone’s liquidity needs over the first quarter
of 1991. How should the bank meet its liquidity requirements?
Liquidity is an important financial aspect in the banking sector because help to
determine the ability of a bank to meet its short-term financial obligations such as maturing
loans and securities. There are two ratios which are commonly used to assess the liquidity of
a bank: the loans to Asset ratio and Loan/ deposit ratio (Mayes, 2013).
Banks which prefer to trade in risk-free securities tend to have higher liquidity ratios.
On the other hand, banks that prefer to trade in liquid deposits have lower liquidity ratio. In
the U.S, the recommended liquidity ratio is 20 percent (Tian, 2016).
Banks face liquidity risk when they cannot meet the financial obligations that come
with an increase in assets or a reduction in the liabilities. Therefore, banks tend to avoid
insolvency by trading in assets which can easily be converted into cash. However holding a
high level of liquid asset causes a low rate of return which leads to low profitability level
(Giovanni, 2013).
a) The loans to Asset ratio
The liquidity ratio is obtained from dividing a bank's loan by its current asset. The
lower loan to asset ratio shows that a bank generates its income from noninterest and
diversified investments such as trading. On the other hand, higher loan to asset ratio shows
that a bank generates its income from loans (Giovanni, 2013).
In the first quarter of 1991, Keystone's loans totaled to $ 39,571 while its current assets
were $ 65,669. Dividing the loans by total current assets, a ratio of 0.60 which is the loan to
asset ratio. Considering that the ratio is less than one, it can be concluded then that Keystone
had a lower liquidity ratio. The bank relied more on diversified investment portfolios and

KEYSTONE NATIONAL BANK ANALYSES 8
noninterest investments to generate income. On advantage of maintaining a lower loan to the
asset, the ratio is that Keystone could survive when the interest rate is high in the market as
well as when the credit terms are not affordable (Lee & Lee, 2010).
b) Loan/ deposit ratio.
Liquidity of a bank can also be assessed by calculating the loan/ deposit ratio. Banks
are judged to be holding unproductive capital when the loan/ deposit ratio is low. On the
other hand, banks can easily be negatively affected by the changes of the deposit base when
the loan to deposit ratio is high (Tracy, 2012).
In the first quarter of 1991, Keystone's loans totalled to $ 39,571 while its total deposits
were $ 33,237. Dividing the loans by total current assets, a ratio of 1.19 which is the loan to
deposit ratio. Keystone can use $1.19 of its current assets (loans) to repay $ 1 of its current
liabilities (customer deposits).
Generally, Keystone had a lower liquidity ratio because it held more unproductive asset
items which cause a low rate of income. Therefore, the banks should dispose-off its
unproductive assets for more productive ones.
Given the outlook for 1991 suggested in Exhibit 6, what specific recommendations
would you make to the management of the Keystone National Bank for improving the
bank’s earnings performance and financial strength?
The demand for loans was expected to increase in 1991 because of the growth in the
three leading sectors in the market. The economic recession was expected to lead to recovery.
Moreover, business activities remained stronger than the expectations. The interest rate was
expected to fall in the short term before raising in the long term. However, if a recession or
weak economic recovery continues in the long run then the interest rate would further drop.

KEYSTONE NATIONAL BANK ANALYSES 9
To remain competitive in the market, Keystone National Bank opted to provide high rate on
core deposits (CD) to increase its customer base (Gray D., 2012).
High-interest rates are associated with higher revenue on loans and other investments in
the banking sector. However, the cost of funding the investments are also high when the
interest rates are high. Banks use debts such as deposits from customers and other securities
to finance loans and other investments. Therefore, high-interest rates have a negative impact
on banks' profitability level if not maintained effectively.
Keystone is likely to face low financial performance and profitability when the interest
rate falls. The deposits from customers are also expected to increase with the growth in the
three market sectors. The attempt by the bank to provide higher rates on deposits, to expand
the market base, is likely to fail because of its inability to fund such expenses from low
performing loans and investments (Zagst, 2013).
Keystone should, therefore;
Improve its liquidity level which would improve its ability to meet the financial
obligations associated with customer deposits and other securities. The banks should improve
its liquidity level by investing more in risk-free government securities instead of over-relying
on liquid deposits from customers (Berger, 2015).
Partially discharge its unproductive capital and assets and acquire productive ones.
With the fall of the interest rates, the bank should hold assets which can easily be converted
into liquid cash. It would take a lot of time before unproductive assets are turned into cash
compared to the productive ones. Holding more productive loans and other investments
improve the financial position of Keystone during the low economic recovery period which
directly leads to improved returns (Ghosh, 2012).

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References
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