How is analysis of banking companies different from manufacturing companies?

Fundamental analysis – the branch of analysis that deals with the fundamentals underpinning the value of a security (be it debt or equity) largely is based on a study of the business model, financial condition & the management of that company.

The business model of a banking company is different in 2 ways as compared to the ‘manufacturing’ sector.

  • It relies on a lot of judgement in decision making – While financial analysis can paint a picture of the past performance and future potential, it is the lender’s judgemental call on the borrower’s willingness & ability that is the backbone of the lending decision.
  • Loss distributions are asymmetrical – When defaults happen, income (interest) stops accruing and the entire principal turns into loss. Thus, the bank faces a double whammy when loan defaults happen.

    For instance, let us consider an investment outlay of Rs.5bn in a new factory that needs to be evaluated by General Manager of a FMGC Company & a lending proposal of similar amount to be evaluated by the Corporate Banking Head of a Bank. What would be the factors they take into consideration in their decision?

 

 

 

 

 

 

 

 

 

Expansion proposal in Company

Lending proposal in Bank

Expected Benefits

Factors Considered

  • Expected demand for product (Volume Growth)
  • Ability to repay loan – Business &operational parameters, Financial Analysis
  • Estimated Price realisation
  • Willingness to pay – Credit history,Management quality

Expected Costs

  • Returns from lending – Benchmarking the rate of interest charged to other companies with similar risk profile, fees, other products that may be offered to the customer

Project parameters

  • Construction & Machinery Cost
  • Location
  • Construction time
  • Connectivity – Labour & Raw material
  • Regulatory considerations – RBI regulations, internal policy parameters like caps on lending to a sector/ tenor restrictions etc.
  • Regulatory considerations – Tax, Labour,Environmental laws
  • Risk factors – Expected probability of default based on ‘what if” scenario analysis
  • Mitigants – Collateral, Covenants etc.

Techniques used

Techniques used

Capital budgeting tools like payback period, NPV etc

Ratios like Return on Equity (ROE), Return on Risk Adjusted Capital(RAROC)

As we saw, the business model of a Bank is completely different than that of a manufacturing company. Therefore, standard metrics used in company analysis like – volume & price growth, gross profit margins, debt to equity ratios etc won’t work in analysis of banks. That is to say, that, while an analyst would look at the same three factors viz. business model, financial condition & management quality, the parameters used within them differ. These are outlined below.

1. Business Overview

  • Business Mix: A breakup between Retail (lending to individuals/ small businesses through the branch network) Corporate lending, Trade Finance (financing import/export) and Project Financing (Funding infrastructure). This will help in understanding tenor of assets (how long is your principal at risk), granularity (size of each loan & therefore impact if it defaults), susceptibility to currency fluctuations, etc.
  • Funding Mix: Share of low cost & sticky CASA (Current & Savings accounts) versus the more fickle but relatively costlier time deposits.
  • Focus: Is it a universal banking offering all services or a retail/corporate/trade focussed bank.
  • Growth strategy: Retail takes longer (and hence costlier) to penetrate into but is relatively less risky. Corporate assets can be built up relatively faster.
  • Efficiency: Metrics like business (loans +deposits) per employee, revenues/profits per employee are used to analyse the efficiency of business

2. Financial Analysis

Select financial indicators that are studied are provided in the table below:

Particular

Prev Yr Actual

Prev Yr Actual

Current Year (Est)

Next yr Projected

Next yr Projected

Revenues

 

 

 

 

 

Net Interest Income($)

 

 

 

 

 

Fee Income ($)

 

 

 

 

 

Operating Expenditure($)

 

 

 

 

 

Profit After Tax ($)

 

 

 

 

 

Net Interest Margin%

 

 

 

 

 

Cost/Income Ratio %

 

 

 

 

 

Capital Adequacy Ratio – Tier I &II %

 

 

 

 

 

Gross NPA %

 

 

 

 

 

Net NPA %

 

 

 

 

 

Return on Assets %

 

 

 

 

 

Return on Equity%

 

 

 

 

 

  • Capital Adequacy % is the minimum amount of capital that must be pumped in for every $100 of risky assets (loans given+ investments) Of this Tier I capital is from equity and equity like instruments & Tier II is by way of hybrid instruments or subordinated debt. The ability of a Bank to source equity at lowest cost and from wide variety of investors and maintain Capital adequacy well above the threshold stipulated by the regulators is a sign of its strength.
  • Asset Quality: The assets (loans/investments) of a Bank are its primary revenue generators. An in depth study of the asset composition will include analysing the maturity profile, industry & geographic concentration and trends in NPA ratios.
  • Earnings Quality: Sustainability is the key here – steady NII growth in $ terms and maintaining a steady NIM signal stable accruals. Fee income boosts profitability and therefore is a key metric; besides ROA & ROE ratios. Cost to Income Ratio is studied to understand what is the amount spent to earn each $ of revenue.
  • Funding Quality: What is the level of dependence on term deposits (wholesale funding). While CASA is sticky it also entails cost in the form of Branch network. Another critical area of study is the Asset Liability Mismatch i.e. the time when assets mature to generate cash inflows versus the time liabilities have to be paid off. A negative mismatch (time when liabilities to be paid exceeds assets maturing) will need to be refinanced.

3. Management Quality

This is a subjective analysis comprising of understanding the Composition of the Board of Directors & Key management of the Bank, frequency of changes in top management. Attrition levels are also analysed across the Bank functions as the key assets for a Bank are its employees.

Types of Investment Banking job

Types of Investment Banking Jobs:

Investment banking is one of the most attractive industry to work in. not only for people with formal education in finance, people with diverse backgrounds
are looking to join this industry not just for the money but for the glamour that this industry offers to individuals.

There are different types of jobs within an investment banking firm. While most of the jobs are with large investment banking firms, like Goldman Sachs,
Morgan Stanley etc., the investment banking wings of large commercial banks such as Citigroup, Deutsche bank etc. besides these, there are many boutique
tehnvestment banks that offer lucrative careers.

Types of Investment Banking Jobs:

  1. Mergers and Acquisitions (M&A):
    M&A bankers specialize in providing companies with strategic advice when they plan to either merge with a competitor or acquire a smaller firm.
    The most fundamental and sound skill that these bankers require is Financial Modeling, which is what they base their suggestions or advices on.
    Highly ambitious individuals who are capable of working extremely long hours with great people skills, tend to pull out a 7 figure for salary as
    they progress their careers. Got the right skills? You might even become a legend executing some of the largest deals.

  2. Underwriting:
    A more traditional role for Investment Bankers has been to assist corporations and governments raising capital, which falls in the purview of the
    underwriting department. Bankers in this department specialize either in debt or equity and might also specialize by industry. These bankers need
    to be able to liaison with their clients in order to determine their capital needs while also working closely with traders and security sales
    personnel inorder to determine the market situation and the price that any security may command in the market. As with most other investment bank
    jobs, underwriters might end up spending extra hours, when working on a deal.

  3. Private Equity:
    private equity jobs are currently the hottest and most prestigious positions in all of finance. The massive compensation and the bonuses on the
    senior members of the firm contribute to this craze. While these jobs can be found within an investment bank, there are many prestigious venture
    capital firms such as Black-stone, KKR and TPG, to get into which one would need to have excellent track record in investment banking or if you’re
    a fresher you need to have more than excellent academic record and it helps if you’re from a top tier university.

  4. Venture Capital:
    While Private Equity firms invest in established companies, Venture Capital firms specialize in investments in New or Startup companies in various
    industries that are particularly fast moving and growing (eg: Bio-technology, green technology, ecommerce etc.,). While many of these companies
    fail, the payoffs from few winners outweighs the losses from many failures. The single most skill that people working in Venture Capital must
    possess is the ability to identify the right opportunities at the right time. Many wish to get into venture capital for this thrill that the jobs
    have to offer. The compensation as with other investment banking jobs is handsome and the work hours are just as long.


Almost all of these jobs demand strenuous working hours but the compensation more than makes up for it. because of the potentially large pay-offs,
competition for these jobs is very fierce. Even though many investment bankers come to their career from prestigious universities and with an MBA. If you
develop the right skills like financial modelling, you should explore these enriching careers.