Question 6.P.10: Crochett National Bank has experienced the following trends ...

If we look at the entire 5-year period, Crochett’s profit margin has remained relatively constant. However, from year 2 through year 5, there has been a significant decline (from 11.63% to 10.2%). This can be viewed as troublesome when we note that net income and total operating revenues have more than doubled during the five-year period. Two potential areas that management should investigate are (1) the mix of funding sources and (2) non-interest expenses.

Since ROE has grown much more rapidly than ROA, we should be concerned that Crochett is increasing its liability sources of funding, thereby increasing its leverage to keep its ROE growing. This can cause serious problems with its income as interest rates rise, driving up its cost of funds.

With regard to its noninterest expenses, if these are growing faster than the bank’s noninterest income, then there is greater pressure on the bank’s net interest margin to offset the increasing negative spread between noninterest income and noninterest expenses.

Since bank regulators place a great deal of emphasis on capital adequacy, these two areas, leverage and noninterest margin, could be moving Crochett to a precarious capital adequacy position.