05july_cover 7/7/05 5:46 PM Page 1

Dominion Bond Rating Service

Lifting the
Lid on Ratio Analysis
for U.S. Banks
New York
One Exchange Plaza July 2005
55 Broadway, Suite 1502
New York, New York 10006 U.S.A.
Tel. (212) 806-3277

Chicago
20 North Clark Street, Suite 803
Chicago, IL 60602 U.S.A.
Tel. (312) 332-3429

Toronto
Corporate Office
200 King Street West, Suite 1304
Toronto, ON M5H 3T4 Canada
Tel. (416) 593-5577

Dominion Bond Rating Service

www.dbrs.com
New York Toronto Chicago
© 2005 Dominion Bond Rating Service. All rights reserved.
05july_cover 7/7/05 5:46 PM Page 2

Authors
Alan G. Reid, William Schwartz, Roger Lister, Benjamin Chen, Les Muranyi, Edward Soffer

contact info
Alan G. Reid
Managing Director, U.S. Financial Institutions Group
Tel. 212-806-3232
Fax 212-635-3278
Mobile 201-317-0882
Blackberry 212-300-6182
areid@dbrs.com

Roger Lister
Chief Credit Officer, U.S. Financial Institutions Group
Tel. 212-806-3231
Fax 212-635-3278
Mobile 908-581-4324
Blackberry 212-731-4399
rlister@dbrs.com

William Schwartz
Vice President - Senior Financial Analyst, U.S. Financial Institutions Group
Tel. 212-806-3233
Fax 212-635-3278
Mobile 201-233-2812
wschwartz@dbrs.com

Les Muranyi
Vice President, U.S. Financial Institutions Group
Tel. 212-806-3236
Fax 212-635-3278
Mobile 201-572-9152
lmuranyi@dbrs.com

Dominion Bond Rating Service (DBRS) is a full-service credit rating agency established in 1976. Privately owned and operated without affiliation to any financial institution,
DBRS is respected for its independent, third-party evaluations of corporate and government issues, spanning North America, Europe and Asia. DBRS's extensive coverage
of securitizations and structured finance transactions solidifies our standing as a leading provider of comprehensive, in-depth credit analysis.

All DBRS ratings and research are available in hard-copy format and electronically on Bloomberg and at DBRS.com, our lead delivery tool for organized, web-based,
up-to-the-minute information. We remain committed to continuously refining our expertise in the analysis of credit quality and are dedicated to maintaining objective and
credible opinions with in the global financial marketplace.
Lifting the Lid on Ratio Analysis for U.S. Banks

SUMMARY
Dominion Bond Rating Service (“DBRS”) provides bank
ratings as a forward-looking measure of a bank’s ability to
meet its financial obligations. At DBRS, each rating is the
product of a detailed qualitative and quantitative analysis.
While the qualitative analysis of the bank’s franchise value
and competitive strategy plays a key role in the rating
process, quantitative ratio analysis of a bank’s financial
health is also considered critical by DBRS in determining a
risk rating.
The DBRS ratio analysis focuses on four interrelated
aspects of a bank’s financial health:
• Earnings Power – The ability to generate consistent
profits and grow capital internally.
• Asset Quality – The potential for losses that could
impair earnings and capital.
• Liquidity – Cash resources available to meet short-term
obligations.
• Capital Adequacy – Ultimate creditor protection against
future losses.
At DBRS, each of the four financial health elements is
measured with a specific set of financial ratios as
summarized below:

DBRS's KEY RATIOS FOR U.S. BANKS

Earnings Power Asset Quality

IBPT/Risk-Weighted Assets NPAs incl. 90 days past due/IBPT

Net Interest Margin NPAs incl. 90 days past due/TCE
Operating Expenses/Operating Revenues Loan Loss Reserves/Gross NPAs
Loan Loss Provision/IBPT Gross NPAs/(Gross Loans + OREO)
Net Charge-Offs/Average Loans

Funding and Liquidity Capital Adequacy

Wholesale Funding Reliance

(Wholesale Funding/(Wholesale Funding + Core Deposits)) Tang. Comm. Equity/Risk-Weighted Assets

Double Leverage (PCO)

Net Short-Term Liabilities/Total Assets ((Subsidiary Equity Investments + Goodwill)/CE)
Core Deposits/Net Loans

Liquidity Coverage Ratio (PCO)

(Eligible Funding/Short-Term Debt Obligations)

OREO = Other Real Estate Owned; TCE = Tangible Common Equity; CE = Common Equity;
IBPT = Income Before Provisions and Taxes; RWA = Risk-Weighted Assets; NPAs = Non-Performing Assets.

This methodology will discuss the key ratios currently used
by DBRS in the process of rating U.S. banks. By sharing
this information, DBRS hopes investors will gain more
clarity about its ratio preferences, the computation of these
ratios, and rating methodologies in general.
Throughout this methodology, DBRS has included graphs
illustrating these ratios for its universe of U.S. bank holding
companies (BHCs). It must be emphasized that these
graphics are solely for illustrative purposes. Future
analytical pieces will focus upon the trends in these ratios
over recent years and on the DBRS opinion of where these
trends are likely to go through the medium term.

U.S. Banking DOMINION BOND RATING SERVICE

Information comes from sources believed to be reliable, but we cannot guarantee that it, or opinions in this Methodology, are complete or accurate. This
Methodology is not to be construed as an offering of any securities, and it may not be reproduced without our consent.

THE STRENGTHS AND LIMITATIONS OF RATIO ANALYSIS
Financial ratios are a valuable analytical tool used to
measure the financial health of a bank. Deterioration in key
ratios can send early warning signals to creditors in a timely
fashion. In addition, ratio analysis can provide a quick
snapshot of a bank’s financial picture and help identify
business and market issues that need to be monitored when
performing qualitative analysis. For instance, deteriorating
asset quality may suggest a weak risk management process.
Declining profitability could signal competitive loan or
deposit pricing, rising cost of funding, or deteriorating
operation efficiency. Financial ratios are most helpful when
interpreted in the context of historical trends and
performance relative to peers.
Ratio analysis at DBRS focuses on time-series data of a
bank. DBRS considers ratios in light of where the bank is
within the economic cycle and identifies the variance in
ratios under different market conditions. Financial
institutions can be highly dynamic and complex
organizations that evolve in response to internal and
external changes. Data at a single point in the credit cycle is
not a valid basis upon which to make a credit judgment or
financial outlook.
Peer group comparison is another important element in ratio
analysis that helps to assess the relative strengths and
weaknesses of a bank. Moreover, many banks have
developed a unique combination of businesses, which
makes it difficult to find true “peers”. In such cases, DBRS
compares financial ratios by “line of business” across
several banks in order to effectively assess the fundamentals
of a bank’s business.
Ratio analysis also has its limitations as an analytical tool
and must be used with caution. Firstly, ratios are indicators
only of financial condition and do not explain what
underlying qualitative factors produce the numbers. Only
through further qualitative analysis can the economic
EARNINGS POWER
In its bank rating methodology, DBRS places strong
emphasis on the earnings of a bank, including both its
magnitude and predictability, as earnings constitute the first
source of capital and liquidity that protect creditors from
default risk. DBRS’s measure of earnings power is
consistent with its forward-looking perspective and risk-
adjusted return approach. With strong and stable earnings
based on sound business fundamentals, capital can grow and
be sustained at an adequate level to protect creditors from
default risk. In contrast, with a weak earnings trend, even a
strong capital base can be eroded and eventually become
inadequate to cushion creditors from credit losses.
Therefore, DBRS views banks with a strong franchise and a
diverse source of earnings, while demonstrating a growing
earnings trend, positively. DBRS values high earnings
quality and sustainability and effective control of overhead
in bank ratings.
Lifting the Lid on Ratio Analysis for U.S. Banks – Page 2
drivers behind the ratios and anticipated future trends be
understood. All DBRS bank ratings are the results of
integrated qualitative analysis of business fundaments and
quantitative measures of financial strength.
Secondly, the benefit of ratio analysis is tempered by the
difference in accounting treatments and financial
disclosures by banks. Many accounting standards are vague
and flexible, which allow leeway for differences. In
addition, the timing of transactions and “window dressing”
can be used to help improve financial ratios. Inadequate
disclosure and lack of transparency can further complicate
matters. For instance, asset quality measures are often
inconsistently reported in banks’ financial statements.
Some asset quality problems could be masked by a rapidly
growing loan portfolio and the timing of charge-offs.
DBRS attempts to mitigate the impact of such factors by
using averages and observing trends of ratios through
economic cycles. Moreover, DBRS considers the impact of
differing accounting standards.
Thirdly, adjustment of off-balance-sheet items in ratio
analysis can be difficult and subjective. Off-balance-sheet
assets and liabilities are common to banks and other
financial institutions and often involve complex strategies
and computer modeling. Common items included are
derivatives on interest rates, currency, securities, or
commodities, loan commitments, letters of credit, unfunded
pension liabilities, and recourse obligations on assets sold or
securitized. Also, banks may have non-financial
contingencies, such as claims and assessments, pending
litigations, labor problems, environmental issues, etc. Many
times, it is very difficult to adjust and quantify off-balance
exposures especially if disclosures by banks are limited.
DBRS identifies the nature and details of off-balance-sheet
items during bank issuer meetings and gives them
appropriate considerations during the rating process.
Four ratios are selected to measure earnings power and
profitability of a bank:
IBPT/Risk-Weighted Assets
IBPT/risk-weighted assets (RWA), as illustrated in Graph 1,
is the first ratio DBRS uses to measure the core earnings
power of a bank and the strength of its business model. The
numerator is income before provision and tax (IBPT) while
the denominator represents Bank of International Settlement
(BIS) RWAs.
This ratio is an alternative measure of earnings power, as
compared to the standard return on average assets (ROAA)
ratio. Traditionally, ROAA has been used as a common
measure of a bank’s profitability. However, the numerator
used in the ROAA calculation, net earnings, may be
distorted by a number of factors including the difference in
loan loss provisioning practice, extraordinary items, and tax
rates across banks. Unlike an actual operating expense
Lifting the Lid on Ratio Analysis for U.S. Banks – Page 3

item, loan loss provision is subject to the discretion of the more accurate measure of economic profitability; one that is
bank’s management. Tax rates on banks could vary more consistent with the risk-adjusted return concept.
significantly and can be impacted by specific tax and
accounting treatments. Such differences make cross-bank Net Interest Margin
comparison of net income difficult. Net interest margin (NIM), as illustrated in Graph 1, is
calculated as net interest income divided by average earning
The IBPT calculation adjusts for these factors to measure assets, including interest-earning securities and loans. Tax-
earnings power more consistently across banks. In addition, exempt interest income is adjusted and net interest income
DBRS considers non-recurring gains or losses in the IBPT is presented on fully taxable equivalent basis. This ratio
calculation to measure core earnings power and make year- takes into account the net impact of the bank’s average
over-year comparisons more meaningful. funding cost and the average yield on its earning assets.
With a superior NIM, the analysis will examine whether the
The denominator in the ROAA formula, average total high margin is the result of low funding costs based on a
assets, does not take the asset risk profile factor into account strong core deposit franchise (a positive rating factor) or
and could unfairly favor those banks taking higher risks to high risk-taking in the asset profile, or both. The same
boost earnings and penalize those banks taking lower risk to analysis is applied for a low margin. Many times, NIM is an
generate consistent earnings. Furthermore, ROAA may be indicator of the strength of the deposit franchise of a bank,
misleading in that it favors those banks that move assets off which can result in a comparative advantage with its cost of
the balance sheet through securitization while still retaining funding, a key profitability driver. A bank with stable and
the economic risk of the assets. By addressing these flaws growing NIM is viewed positively in the rating process.
in the ROAA measure, the IBPT/RWA ratio is designed as a
Graph 1
Earning s Po we r R atio s
fo r B ank H o lding C o mpanie s (% )
4 .5
4 .2 9

4 .0
3 .9 0
N e t In te re s t M a rg i n
3 .5

3 .0

2 .7 3 2 .4 9
2 .5
IB P T/R W A
2 .0
2000 2001 2002 2003 2004

N o te s : R a tio s c o m p u t e d b y u s in g a m e d ia n a p p ro a c h fo r 3 7 9 b a n k h o ld in g c o m p a n ie s . IB P T = In c o m e B e fo re P ro v is io n a n d T a xe s ; R WA = R is k -We ig h t e d
A s s e t s . S o u rc e : S N L F in a n c ia l; D B R S A n a lys is .

Operating Expenses/Operating Revenues by the core earnings of the bank. This ratio serves as an
This ratio, as illustrated in Graph 2, is an indicator of indicator of the level of credit losses that the firm could
operating efficiency as measured by the percentage of non- withstand in times of financial stress given its earnings
interest expenses over total operating revenues. The power. In other words, the lower the ratio, the better the
calculation of this ratio adjusts for non-recurring profits and coverage for potential future provisioning requirements.
expenses. A lower ratio suggests better cost control and This ratio is also considered a risk-adjusted profitability
possibly lower fixed costs and thus a better chance to measure. When a bank takes additional risk to increase
weather a challenging economic cycle when total revenues earnings, its loan loss provision may also need to increase to
may decline. DBRS looks at the operating cost structure of cover higher credit losses in assets. Higher loan losses
a bank. The higher percentage of fixed costs in operating could offset higher earnings; as a result, its loan loss
expenses, the weaker the financial flexibility of a bank. A provision/IBPT coverage may not improve from such a risk-
more operationally efficient bank is better leveraged to taking strategy.
expand its franchise while maintaining its profit margins.
At the same time, it should be remembered that this ratio However, because of the discretionary nature of the loan
should be used carefully in comparing banks with different loss provision, this ratio may not reflect the earnings power
business mixes and that this ratio is impacted by the of a bank when it keeps its provision artificially low to
revenues side as well as the expenses side. inflate its net earnings. In this case, DBRS examines the
historical trends of provisioning and also the changes over
Loan Loss Provision/IBPT time in reserve adequacy to assess the earnings power of a
Loan loss provision/IBPT, as illustrated in Graph 2, bank relative to its need for provisioning.
measures how well potential loan losses may be absorbed
 Lifting the Lid on Ratio Analysis for U.S. Banks – Page 4

Graph 2

Earnings Power Ratios

for Bank Holding Companies (%)
70
60.23
60
59.92
50
O perating Expenses/O perating Revenue
40

30

20
10.42
10
8.48
Loan Loss Provision/IBPT
0
2000 2001 2002 2003 2004

No tes : Ra tio s co mpute d by us ing a median appro a ch fo r 379 ba nk ho lding c o mpanie s . IBP T = Inc o me B efo re P ro vis io n a nd Taxe s
S o urc e : S NL F ina nc ia l; DBR S Ana lys is .

ASSET QUALITY
Asset quality impacts future profits and losses through
provisioning, and charge-offs and credit losses can
eventually impair capital. Therefore, asset quality analysis
is an integral part of the DBRS quantitative assessment.
DBRS evaluates asset quality to understand how asset
performance could impact future profitability, capital
adequacy, and financial flexibility. DBRS rates favorably
those banks that have very low levels of non-performing
assets (NPAs), consistently low levels of net charge-offs,
and top reserve adequacy among peers through a full
economic cycle. In addition, DBRS analyzes loan
concentration risk by industry, individual relationships,
region, and loan category relative to total loan portfolio,
core earnings, or tangible common equity during asset
quality assessment. The more granular the loan portfolio is,
the lower the likelihood of catastrophic losses on a few
large exposures.
Five ratios are employed by DBRS to measure NPAs and
charge-off levels relative to total loans, core earnings,
capital, and reserves:
NPAs Including 90 Days Past Due/Income Before Loss
Provision
This ratio, as illustrated in Graph 3, measures the potential
impact of a bank’s asset quality problems on its core
earnings. Specifically, it intends to estimate how much the
pre-provision, pre-tax income of the bank could be reduced
if one assumes that all NPAs and loans of 90 days past due
have to be fully charged off. This is also a measure of a
bank’s ability to earn out of its asset problem without
impairment on its capital in an extreme scenario.
NPAs Including 90 Days Past Due/Tangible Common
Equity
This ratio, as illustrated in Graph 3, measures the potential
impact NPAs may have on capital adequacy. The larger this
ratio is, the greater the impact credit losses from NPAs may
have on capital and the less equity cushion creditors may
have to protect them from further losses.
Lifting the Lid on Ratio Analysis for U.S. Banks – Page 5

Graph 3

Asset Quality Ratios

for Bank Holding Companies (%)
30

25
24.93 (NPAs Incl. 90 Days Past Due )/IBPT
20 22.00

15

10
6.96 6.15
5
(NPAs Incl. 90 Days Past Due )/TCE
0
2000 2001 2002 2003 2004
No te s : R a tio s c o m pute d wa s us ing a m e dia n a ppro a c h fo r 379 ba nk ho lding c o m pa nie s . * IB P T = Inc o m e B e fo re P ro vis io n a nd Ta xe s ; NP As = No n-pe rfo rm ing
As s e ts . S o urc e : S NL F ina nc ia l; DB R S Ana lys is .

Loan Loss Reserves/Gross NPAs

Loan loss reserves/gross NPAs is a reserve adequacy ratio
measuring how well a bank’s profitability and capital are
cushioned from future credit losses. Loan loss reserves are
provided to cover expected losses in the loan portfolio and
loan losses on NPAs will be first absorbed by loan loss
reserves before impacting earnings and capital. The higher
the reserve adequacy ratio, the lower the probability that
NPAs may hamper future profitability and/or impair core
capital base, particularly when asset quality deteriorates in a
market downturn and a significant increase in provision is
required. (See Graph 4.)

Graph 4

Asset Quality Ratios

for Bank Holding Companies (%)

250
239.58
230.82
230

210

190

170 Loan Loss Reserves/Gross NPAs

150
2000 2001 2002 2003 2004
No te s : R atio s c o mputed was us ing a me dian appro ac h fo r 379 ba nk ho lding c o mpa nie s . * IB P T = Inc o me B efo re P ro vis io n and Ta xes .
So urc e: SNL Financ ial; DBR S Analys is .

Gross NPAs/(Gross Loans + Other Real Estate Owned) for banks with rapidly growing loan volume or large and
In this ratio calculation, as illustrated in Graph 5, gross swift charge-off. DBRS incorporates loan growth, aging,
NPAs are the sum of non-performing loans, foreclosed real and charge-off practice of a bank into the peer comparison
estate, and other non-accrual and repossessed assets. The of this asset ratio. Whenever possible, DBRS analyzes asset
denominator is total gross loans plus foreclosed real estate. portfolio performance on a static pool basis versus a
This traditional loan quality statistic is an indicator of the dynamic pool basis.
NPAs level in the portfolio and is often used as the standard
proxy for bank credit quality. However, caution should be
used in that the ratio can be misleading with a positive bias

Net Charge-Off/Average Net Loans
Net charge-off/average net loans ratio is illustrated in Graph
5. This formula refers to total loan and lease charge-offs
less recoveries. Average net loans are loans and leases net
of unearned income and loan loss reserves. This ratio
reports the actual loan losses that a bank has incurred and it
is used in conjunction with Gross NPAs/(Gross Loans +
Graph 5
Asset Quality Ratios
for Bank Holding Companies (%)
0.75
0.60
0.55
0.45
0.30
0.19
0.15
Ne t Charge -O ffs/Avg. Ne t Loans
0.00
2000 2001
No te s : R a tio s c o m pute d wa s us ing a m e dia n a ppro a c h fo r 379 ba nk ho lding c o m pa nie s . OR EO = Othe r R e a l Es ta te Owne d
S o urc e : S NL F ina nc ia l; DB R S Ana lys is .
FUNDING AND LIQUIDITY
Lack of access to funding sources and weak liquidity
management are typical factors that lead to bank failures.
Without adequate cash resources to meet short-term
liquidity requirements, a bank will find it impossible to
continue its operation even if its capital or solvency remains
acceptable. Liquidity and other elements of asset liability
management, including interest rate risk, offer valuable
insights into the operations of an institution. DBRS
believes that those banks with a strong, stable, and well-
balanced deposit base along with substantial investments in
liquid assets have a greater ability to weather short-term
setbacks. DBRS also incorporates a bank’s liquidity
management and contingency planning when performing a
liquidity review.
DBRS uses three ratios at the bank level and one ratio at the
parent company level as indicators to identify banks and
BHCs that may have less than adequate liquidity. However,
DBRS’s analysis of bank liquidity is not restricted to these
ratios. Within the review process, DBRS evaluates a bank’s
access to a variety of funding sources, such as the Federal
Reserve discount window and Federal Home Loan Bank
(FHLB) lines and lines of credit and back-up facilities, a
bank’s correspondent banking relationships, and the ability
of a bank to sell or securitize loans and other assets to
weather a liquidity stress. It is important to note that the
liquidity and quality of an institution’s assets play a major
role in its ability to manage a liquidity crisis. An institution
that has lower quality assets that are illiquid and/or whose
market value is highly volatile will clearly face greater
Lifting the Lid on Ratio Analysis for U.S. Banks – Page 6
OREO) to signal asset quality, as the latter may be distorted
by the magnitude and pace of loan charge-off. This ratio
combined with the previous ratio presents a more complete
picture of asset quality. However, one limitation for this
ratio is that the cost of recovery, including administration
and legal expenses, is not included in the calculation, which
could be substantial in many cases.
Gross NPAs/(Gross Loans + O REO ) 0.54
0.18
2002 2003 2004
liquidity challenges than an institution with high quality
easily quantifiable assets. DBRS carefully evaluates each
institution’s asset profile as part of assessing overall
liquidity.
DBRS also believes that large banks with diverse business
lines and an extensive client network generally have better
liquidity and financial flexibility as they maintain a
relatively broad deposit base (in terms of product types,
maturity distribution, geographic dispersion through branch
networks, and customer base diversification), more
diversified wholesale funding sources, and more third-party
supports. On the other hand, the liquidity of smaller banks
or specialized lenders is more likely to be constrained by
their reliance on specific sources of funding, either deposits
from a narrow region or single wholesale market sources.
DBRS reviews liquidity at both the subsidiary bank and the
parent company levels. From a ratings perspective, DBRS
views entities with sound liquidity at both the subsidiary
bank level and the parent company positively, while
considering weak parent holding company and weak bank
liquidity a ratings constraint. Between the two extremes,
DBRS is relatively comfortable with those entities that
display sound bank liquidity but have weak parent holding
company liquidity. For entities that fit this category, but are
otherwise financially sound, DBRS thinks that weak parent
holding company liquidity can be more easily fixed. This
can be achieved either through upstreamed dividends from
subsidiary banks that increase available liquid assets, or
Lifting the Lid on Ratio Analysis for U.S. Banks – Page 7
through an improvement in the debt profile, for example by
the issuance of long-term funding instruments by the parent
holding company. DBRS considers those entities with
sound parent holding company liquidity, but weak bank
liquidity less favorably in the context of its ratings. This is
because there is no quick fix for weak bank liquidity.
Structurally, weak bank liquidity is difficult to change given
that it generally reflects a bank’s intrinsic business model.
The detailed discussions of bank and BHC liquidity and
related financial ratios can be found in the recent research
commentary “Bank and Bank Holding Company Liquidity –
Assessing How Full the Glass Is” published on April 11,
2005.
The following three liquidity ratios are used at the bank
level:
Wholesale Funding Reliance
This ratio, as illustrated in Graph 6, is calculated as follows:
Wholesale Funding Reliance = Wholesale Funding/(Core
Deposits + Wholesale Funding)
Wholesale funding includes federal funds (fed funds)
purchased, repurchase agreements (repos), non-core
deposits, FHLB loans, subordinated debentures and notes,
mandatory convertible notes, and other borrowings.
Core deposits = total domestic deposits – domestic (jumbo
CDs + brokered deposits); non-core deposits = total deposits
– core deposits
This ratio measures the percentage of a bank’s total funding
that comes from wholesale market sources and non-core
deposits. While providing banks with greater flexibility in
the context of asset and liability management, wholesale
funding tends to be more credit and confidence sensitive,
and therefore incorporates a degree of “rollover risk”. A
Graph 6
Funding and Liquidity Ratios
for Bank Holding Companies (%)
35
Whole sale Funding Re liance *
30 28.90
25
20
15
14.65
10
5
Ne t Short-Term Liabilitie s/Total Asse ts
0
2000 2001
No te s : R a tio s c o m pute d wa s us ing a m e dia n a ppro a c h fo r 379 ba nk ho lding c o m pa nie s . * Who le s a le F unding R e lia nc e = Who le s a le F unding/(C o re De po s its +
Who le s a le F unding) S o urc e : S NL F ina nc ia l; DB R S Ana lys is .
high level of reliance on the wholesale funding market
raises the risk that a bank faces liquidity pressure. If the
markets lose confidence in the bank, the bank is likely to
struggle to roll over its wholesale market borrowing. Core
deposits are more likely to be rolled over or left in the bank
rather than withdrawn – hence the expression “sticky”
deposits. The risk of rollover difficulties is likely to be
heightened to the extent that that the bank is viewed as
having limited liquid asset resources to meet its obligations.
Net Short-Term Liabilities/Total Assets
This ratio, as illustrated in Graph 6, is calculated as follows:
(Short-Term Liabilities – Short-Term Assets)/Total Assets
Short-term liabilities include all borrowings and time
deposits with a maturity within one year. Short-term assets
comprise all loans and securities with a remaining maturity
of less than one year, plus fed funds sold and reverse repos.
The ratio looks at a bank’s reliance on short-term funding
that exceeds its holding of short-term assets. It is an
indicator of the risk assumed by the bank in funding assets
with short-term liabilities. Generally, the higher the ratio,
the more exposed a bank is to short-term funding risk. A
negative ratio is good.
Banks are highly leveraged financial institutions with net
earning generally below 3% of total liabilities. Therefore,
in a stress scenario, assets instead of earning-derived cash
flows constitute major payment sources for debt obligations
and a primary source of liquidity. The above ratio intends
to measure how assets and liabilities are matched or
mismatched within a one-year horizon. How a bank
manages its assets and liabilities and aligns assets and
liabilities in terms of maturities and currencies is an
important element in DBRS’s liquidity assessment of the
bank.
30.61
5.99
2002 2003 2004
 Lifting the Lid on Ratio Analysis for U.S. Banks – Page 8

Core Deposits/Net Loans
This ratio, as illustrated in Graph 7, indicates the extent to
which the typically less liquid portion of a bank’s asset base
is funded with stickier deposits. This ratio measures the
strength of deposits as a funding source and considers both
the volume of total deposits of the bank, as well as the
structure and quality of the deposit mix. DBRS believes
that non-core deposits, including jumbo CDs and brokered
deposits, are more credit sensitive and are, therefore, more
sensitive to “rollover” risk. As such these deposits are
generally considered a less stable funding source.
The lower this ratio, the more reliance a bank has on non-
core deposits and wholesale market sources to fund the loan
portfolio. A low ratio suggests a bank is exposed to
potential vulnerability in credit-sensitive funds providers at
less favorable points in the credit and economic cycles.
However, this ratio does not consider the ability of a bank to
sell loans or to pledge loans to secure borrowings from
institutional and regulatory entities. With the ongoing
developments in loan markets and securitization, such sales
are more readily undertaken. To the extent that a bank has
readily saleable or pledgeable loans and the capability to
accomplish sales, some of this risk is mitigated.
Nevertheless, banks that are facing a loss of market
confidence are also likely to find it more difficult to sell
loans. DBRS considers these factors as part of its ratings
review process.
The liquidity at the parent company level is measured with
one ratio:
Liquidity Coverage Ratio (Parent Company Only)
Liquidity Coverage Ratio = eligible funding/short-term
payment obligations
Liquidity coverage ratio for a parent company only (PCO) is
defined as the degree to which short-term payment
obligations can be covered by eligible funding sources. The
optimum position for any parent company is for eligible
funding sources to equal or exceed obligations. In other
words, it is optimal for a parent company to have a liquidity
coverage ratio of over 100%.
Where PCO obligations exceed eligible funding sources,
DBRS’s analysis will focus upon the size of the excess, as
well as the robustness of the subsidiary bank liquidity
positions. Strong bank liquidity combined with a relatively
small shortfall would somewhat mitigate this position.
Those funding sources DBRS considers to be eligible, and
ineligible, are detailed as follows:

Eligible Funding Sources Mandatory Obligations

• Cash and balances due
• Securities
• Fed funds sold and reverse repos
• Interest income
• Management fees from subsidiaries
• Unrestricted non-bank sub. dividends
• Other operating income
• Short-term obligations, like CP
• Interest payment
• Short-term non-borrowing liabilities
• Term borrowing maturing within one year
• Operating expenses

Ineligible Funding Sources Contingent Obligations

• Dividends from bank subsidiaries • Ordinary dividends
• Other calls on parent resources, e.g. guarantees on foreign subs.

DBRS believes a PCO should be able to maintain its
ordinary dividend payment, even if dividend upstreaming
from the subsidiary banks is interrupted. This is primarily
because DBRS thinks there is a significant reputation risk
associated with a BHC not fulfilling its ordinary dividend
obligation. By not paying an ordinary dividend, a BHC
sends a signal to the market that it is experiencing liquidity
constraints. Non-payment also illustrates the fact that
management has been ineffective in managing liquidity.
These signals to the market are likely to further pressure a
holding company’s liquidity. Therefore, DBRS includes a
one-year ordinary dividend payment in short-term payment
obligations in the denominator of the liquidity coverage
estimation.
A parent company can improve its liquidity profile if it can
refinance short-term debt with long-term debt. On the other
hand, the liquidity of the parent company could be
pressured if it pursues large-scale acquisitions, dividend
payments, and stock buybacks. Graph 7 illustrates the PCO
liquidity coverage.
 Lifting the Lid on Ratio Analysis for U.S. Banks – Page 9

Graph 7

Funding and Liquidity Ratios

for Bank Holding Companies (%) Core Deposits/Ne t Loans
110

100 97.01 93.08

90

80
Liquidity C overage (PC O )** 72.88
70

60
49.44
50

40
2000 2001 2002 2003 2004
No te s : R a tio s c o m pute d wa s us ing a m e dia n a ppro a c h fo r 379 ba nk ho lding c o m pa nie s . *C o re De po s its = To ta l Do m e s tic De po s its - (J um bo C Ds + B ro ke re d
De po s its . ** Liquidity C o ve ra ge = Eligible F unding/S ho rt-te rm Obliga tio ns ; P C O = P a re nt C o m pa ny Only. S o urc e : S NL F ina nc ia l; DB R S Ana lys is .

CAPITAL ADEQUACY
Capital adequacy is the ultimate line of protection against well as the term. For this reason, DBRS uses tangible
any expected losses from credit risk, market risk, operation common equity/RWAs ratio as a more comparable measure
risk, or other sources. Also, capital is required to protect of capital adequacy across banks with different capital
depositors, creditors, investors, and counterparties of the structures. The RWAs as the denominator reflects the
respective banks from unexpected losses and general concept of risk-adjusted capital adequacy concept and
uncertainty. DBRS believes, with a forward-looking attempts to normalize institutions of different asset profiles.
perspective, that capital by itself is not an effective predictor A higher ratio indicates stronger capital strength and
of future financial difficulty. DBRS analyzes the cushion to protect creditors from potential losses. (See
composition, level, and creation of capital to help define the Graph 8.)
bank’s ability to take risks. Capital adequacy is judged
against relative profitability, the bank risk profile, and asset Double Leverage (PCO)
quality. DBRS has a greater comfort level with those banks This is a statistic to estimate how much debt a BHC uses to
that have core capital well above regulatory requirements fund its equity investments in its subsidiaries. It is
and possess easy access to global capital markets with calculated with the sum of total equity investments (plus
favorable terms. goodwill and intangibles) in subsidiaries divided by the total
equity capital. This ratio is calculated at the parent
Two key ratios measure capital strength and leverage risk: company only level. Subsidiaries include bank, BHC, and
non-bank subsidiaries. A BHC depends on upstreamed
Tangible Common Equity/RWAs dividends from its subsidiaries as the major payment source
This ratio measures a bank’s core capital position. Tangible for its debt obligations. However, dividend payment to the
common equity = total equity – preferred stock – goodwill parent company may be interrupted by regulatory bodies in
and other intangibles excluding mortgage servicing rights. a financial distress scenario. The assets at the bank levels
RWAs refer to BIS RWAs. DBRS selects this ratio as its would be used to pay depositors and creditors of the bank
key indicator of capital strength, although DBRS also first before any proceeds go to the creditors of the BHC. In
reviews regulatory capital ratios, such as Tier I ratio, total other words, the creditors of the parent company are
capital ratio, and leverage ratio. Unlike regulatory capital structurally subordinated to the depositors and creditors at
ratios, DBRS uses tangible common equity, instead of total the bank level. Due to the BHC’s uncertain access to the
capital or Tier I capital, as the numerator in this calculation, resources of its subsidiary banks, higher double leverage
because the composition of total capital or Tier I capital ratio at the parent company level suggests higher possibility
varies across banks and certain components to total capital that the BHC may suffer an operating loss and face
or Tier I capital, such as hybrid instruments, may not be difficulty in servicing its own debts, which tend to increase
available to absorb credit losses in some cases, depending the cost of raising additional funds from capital markets.
on the debt or equity nature of the capital components as (See Graph 8.)
 Lifting the Lid on Ratio Analysis for U.S. Banks – Page 10

Graph 8

Capital Adequacy Ratios

for Bank Holding Companies (%)
10.20 112.00
110.09
10.00 110.00

9.88 Tangible Common Equity/Risk-Weighted Assets 108.00

9.80
106.00
9.60
104.00
9.40
102.00
Double Leverage (PCO )* 9.24
9.20 100.91 100.00
9.00 98.00
8.80 96.00
2000 2001 2002 2003 2004

No tes : Ratio s co mputed wa s us ing a media n appro ac h fo r 379 bank ho lding c o m panie s . * Do uble Leverage = (Sum o f To ta l Equity Inve s tme nts +
Go o dwill & Intangible s )/To ta l Equity Capita l; P CO = P are nt Co m pa ny Only. So urc e: S NL F inancial; DBRS Analys is .
05july_cover 7/7/05 5:46 PM Page 1

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