Financial analysis concepts and applications

STI vs. USB

The capital accounts for the two banks reveal a significant difference in the price-to-book ratios. Suntrust Banks has an equity value that is higher than the market cap of the company, a favorable price-to-book ratio that implies the company is undervalued on the market. U.S. Bancorp has a more typical price-to-book ratio where the market value of the firm is higher than the book value. Part of this difference is that U.S. Bancorp is experiencing modest sales growth, while Suntrust is facing sales declines in excess of 5% annually, such that its expected future worth is lower than its current worth.

For banks, the primary asset is the net loans, along with a category known as "other earning assets," which the annual report for Suntrust reveals to be securities available for sale, or short-term investments that the bank hold and upon which it earns interest. Other assets do not need significant explanation -- goodwill, cash, premises & equipment are all standard asset categories. The loans that the bank makes are its primary assets, and it earns interest on these loans. Of interest to an investor today is the amount of loans that are expected to be bad. There are two adjustments noted on the Suntrust balance sheet, one for loans held for sale and the allowance for loan and lease losses. The latter is 2% for Suntrust as of the end of 2011 and for U.S. Bancorp is 2.2%, both figures that appear to be within industry norms.

3. For banks, non-current assets are usually not material. They are typically real estate, equipment and goodwill. The loans, which are a current asset, are by far the most important asset at a bank.

4. Both companies outline in the notes to the financial statements their policies on deferred income taxes. In each case, these primarily reflect the differences between amounts used in financial reporting and amounts used in tax reporting.

5. The current assets at banks are mainly in the form of loans and investments. The current liabilities are typically in the form of deposits. Banks do not make strong differentiation between current and long-term assets and liabilities. The best estimate of current assets at a bank would be cash and loans; current liabilities would be deposits and short-term borrowings. Suntrust has a current ratio of 1.15, same quick ratio because it lacks inventories, and a cash ratio of 0.05. U.S. Bancorp has current and quick ratios of 1.12 and a cash ratio of 0.03. The low cash ratios are not cause for alarm because in banking, the bank makes money by lending out its money -- a bank sitting on too much cash is a bank that is not earning for its shareholders.

6. The issue of too much debt is slightly different for a bank, since deposits are liabilities and they are necessary to function. Thus, total debt is a bad measure for a bank. Long-term debt, however, can be taken into consideration. Suntrust has a long-term debt to assets ratio of 5.4%, compared with 7.2% for U.S. Bancorp. This indicates that U.S. Bancorp has a somewhat higher debt load. If CB&M wants to add debt to these banks, both appear to have the capacity to take it, since both have a substantial amount of equity still on the books. However, the deposits place a constraint on how much long-term debt the company can bear -- in both cases CB&M would not be able to finance the deal entirely with debt.

7. There are no hidden assets. The biggest risk lies in hidden liabilities such as off-balance sheet items or risks that are greater than are presently recorded.

1. U.S. Bancorp is the more profitable of the two companies. It has a greater ROA, ROE, gross margin and net margin than does Suntrust Banks. The total asset turnover, however, is better at Suntrust (6% vs. 5.7%). Banks do not record other metrics useful in calculating efficiency ratios, such as accounts receivable or inventories.

2. CB&M can do two things to make these banks more profitable. When the income statements are examined, there are two main cost factors. The first comes from operational expenses. If CB&M can bring the operational expenses as a percentage of revenue down, it will be able to increase the profitability of either of these banks. The other cost is the loan loss provision. Thus, if CB&M can improve the quality of the loan portfolios of either bank, then it will also improve the profitability. Improving loan quality often comes via being more selective about lending, so there might be revenue offsets as the result of that tactic, but if the company can find a way to increase loan quality without reducing the amount of funds loaned, it would increase its profitability.