Southwest State Bank Case - Profitability/Swot Analysis

Key Trends Identified in SSB's Profitability from 1991 through 1993

According to the calculated ratios in Table-1, SSB had the following major trends in profitability during the time of 1991 to 1993:

* Decreasing return on equity (ROE) - shareholder return

* Gradual & unsteadily decreasing return on assets (ROA) - managerial efficiency

* Decreasing net non interest margin - less profit earned on non-interest banking components

* Increasing earnings spread - have established effective processes of borrowing and lending money with little immediate threat of competitors

* Unfavorably increasing operating efficiency ratio - there is an excess of operating cost in relation to operating revenues generated by SSB.

* Declining credit risk/depositor risk - decline of bad loans, increased market values of good loans relative to amount of deposits.

* Increasingly higher interest rate risk - meaning that there is about 30% of excess interest sensitive assets compared to interest sensitive liabilities.

SSB's Major Strengths and Weaknesses in Terms of Profitability at Year-End 1993

According to the calculated ratios in Table-1, SSB had the following strengths and weaknesses.

Strengths:

* Slightly increasing net interest margin (NIM): This indicates favorable control and management of interest income and interest expenses, in relation to SSB's total assets.

* Increased earnings spread: This indicates that SSB has established effective borrowing and lending processes. This also indicates a period of non-increasing competition, so SSB can continue to operate on this strength for a little while.

* Consistently steady asset utilization ratio: This reflects a consistent portfolio management policy, considering the yield and mix on SSB's assets. When compared to the industry average for SSB's local area, management can determine if any changes should be made in this area.

Weaknesses:

* Decreased return on equity (ROE): which indicates a decreasing rate of return flowing to shareholders, which is to be a primary area of concern, especially if no significantly unusual circumstances exist, to which one can attribute the ROE decline.

* Gradually decreasing return on assets (ROA): This indicates a steady decline in managerial efficiency, which isn't of extreme threat right now, but could grow into a bigger problem if not addressed early on by SSB's management.

* Decreased net profit margin (NPM): This indicates less effective cost control and management of service pricing. Management should carefully examine both areas, looking for areas related to net income and total revenues that can be quickly adjusted, even possibly decreasing costs and restructuring SSB's pricing of services.

* Decreased net operating margin (NOM): This indicates a need for management and SSB's staff to better manage the revenues generated and operating cost incurred.

* Unfavorable change in operating efficiency: This indicates that SSB has more expenses compared to profits. It appears that SSB is increasingly sacrificing profits by operating more expensively and less efficiently.

* High interest rate risk: The interest sensitive assets exceed the interest sensitive liabilities by about 30%, leaving SSB vulnerable to losses incurred from falling interest rates.

Opportunities and Threats SSB Faces at Year-End 1993

According to the calculated ratios in Table-1, SSB has the following opportunities and threats.

Opportunities:

* Targeting a more favorable operating efficiency ratio, even allowing the goal to be a long-term goal to be addressed over the next 3 years.

* Aggressively continue to better net interest margin (NIM). SSB has so far successfully managed interest income and interest expenses, in relation to SSB's total assets, and should continue to pursue that strength from now on.

* Focus on increasing earnings spread, since it appears that SSB has mastered an effective process of borrowing and lending money. This is a great strength to carry with them as SSB grows into future opportunities. This also indicates that management has a little time to find other ways to generate income from potentially new services, before the competition increases and the earnings spread takes a drastic decline.

Threats:

* An increasingly unfavorable operating efficiency could be a potential drain on SSB's business if SSB does nothing to monitor and stabilize the operating expenses and increase the operating revenues.

* An unfavorably decreasing net profit margin (NPM) highlights management's lack of effective cost control and service pricing. Management should carefully examine NPM, looking for ways to favorably adjust net income and total revenues, possibly by decreasing costs and restructuring SSB's pricing of services.

* The gradually decreasing return on assets (ROA) is an indicator of decline in managerial efficiency could grow into a bigger problem if not addressed early on by SSB's management. Especially if SSB anticipates changes in the market due to regulation or competitors approaching the local area.

Strategic Recommendations for the Bank's Board of Directors

Based on the analysis of the calculated ratios in Table-1, the SSB Board of Directors' recommended course of action is as follows:

* Prepare shareholders to face more modest earnings per share and a hopefully temporarily decreasing ROE, allowing the funds normally distributed to shareholders to be put toward growth opportunities for SSB's future benefit.

* Seriously consider the option of expanding customer segment served, offering financial services that could stimulate the growth of SSB's current and future business opportunities over the next few years. SSB's current future relies primarily on customers connected to the agriculture industry and should the industry face a drastic challenge, SSB will be significantly affected. By diversifying the customers served by SSB, having customers from various communities and various industries, SSB

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