Previous Document in Exam Manual

Next Document in Exam Manual

Exam Manual Table of Contents

An analytical review involves breaking down data (financial, asset quality statistics, etc.) into its constituent parts to determine either its nature or proportions. Analytical review can be used in a variety of ways throughout the examination process. For example, it provides an understanding of the institution's operations and highlights potential problem situations which, if detected early, might avert more serious problems. It can also be used for planning or monitoring purposes to detect trends and conditions that may require inclusion in the scope of examination.

The remainder of this section discusses the tools available to facilitate analytical review and different analytical techniques or methods. Regardless of the tools or methods used, analytical review requires professional judgment and an inquiring attitude.

Analytical Tools

Examiners have a variety of tools available to conduct an analytical review, including institution-prepared information, FCA data bases, and other external information. Business plans, operating budgets, asset quality statistics, and financial statements are just a few examples of the types of institution-prepared information available.

In addition to these, FCA has several data bases and reports to assist examiners in analytical review, such as the Loan Accounting and Reporting System (LARS), Uniform Performance Reports (UPR), Uniform Peer Performance Reports (UPPR), Key Indicators Report (KIR), and the Early Warning System (EWS). While these information sources may contain similar information, each was designed for a different purpose and therefore should be used accordingly. A description of each follows.

LARS--Contains various loan data including the outstanding balances, performance statuses, classifications, and interest rates in a given institution. In essence, this system constitutes the subsidiary ledgers for the primary assets on the books of Farm Credit System (System) institutions. This information can assist examiners in such areas as identifying concentrations and levels of risk, evaluating the implementation of interest rate programs, and developing examination loan samples.

UPR--Provides examiners with key statistical data and ratios to assist in identifying performance trends. Although these reports contain many of the ratios used for general financial statement analysis, the UPR does not, in itself, constitute a complete analysis of the conditions or trends in an institution. Rather, it is designed to facilitate peer group comparisons and enable examiners to quickly identify areas of performance requiring a more detailed analysis. Proper use of the UPR requires that examiners thoroughly understand how the various ratios are calculated and the significance of the data to the condition of the institution.

UPPR--An enhancement of the UPR. It includes peer averages and percentile rankings for all direct lender associations falling into one of four designated peer groups (peer groups are based on total assets). The purpose of the UPPR is to show how a group of direct lender associations of similar size has performed. This information can be used as a benchmark against which to assess an individual association's overall performance, capital position, asset quality, and liquidity.

A percentile ranking is a simple statement of statistical fact; it does not imply a good, bad, satisfactory, or unsatisfactory condition. However, when analyzed within the context of other data, an opinion can be formed about the potential relevance of the percentile ranking to an association's financial condition and performance.

Examiners must consider association lending characteristics when interpreting the peer averages and percentile rankings. For example, a particular association may fall into a favorable (or unfavorable) percentile group based on its lending authority, recent restructuring, or downloading of assets from the district bank. Also, banks are not included in the UPPR because differences among System banks in asset size and type of lending make it infeasible to establish a peer group.

KIR--An extension of the UPR. It is a one-page management report that identifies an institution's financial performance through selected ratio percentages.

EWS--A mathematical model designed to predict the composite CAMEL rating based on the prior established relationships between institutional financial performance and OE-assigned composite CAMEL ratings. The model is used to predict CAMEL ratings for direct lenders based on the most recent Call Report data. As an example, for an association examined as of March 31, 1993, and assigned a CAMEL rating of 3, EWS might predict that the CAMEL rating would be a 4 if the association's examination were based on the December 31, 1993 CRS data. In this way, the EWS is a useful tool as an identifier of possible deteriorating financial condition (or red flags) between examinations and the effect of such deteriorations of CAMEL. However, the model only flags institutions based on financial results. Follow-up review and judgment by the examiner are necessary to determine the degree of concern and need for further monitoring.

Since the model is based on past relationships between financial performance and OE-assigned CAMEL ratings, it also can be useful to highlight those institutions whose performance in key areas falls outside the norm established for CAMEL ratings of similar institutions. Falling outside the norm, however, is not always indicative of a weakness. To determine if a weakness exists, examiners must conduct additional analysis. The EWS only identifies those institutions that, on the basis of a mathematical relationship, present a high probability of operating deficiencies.

Analytical Methods

There is no standard approach or format for conducting an analytical review. The approach selected by the examiner depends on the condition of the institution and its operating environment, as well as the examiner's experience level. While several analytical methods can be employed, three of the more common types are peer group analysis, actual versus projected performance, and ratio analysis. The remainder of this section provides a brief description of each type.

Peer group analysis--A technique used to measure institution performance against other similar institutions. Such an analysis indicates whether an institution is average, above average, or below average in relation to its peers. If an institution's performance falls out of the range achieved by similar institutions, weaknesses may exist. However, further analysis is needed to confirm a weakness.

The key to a meaningful peer group analysis is a homogeneous peer group; the institution being evaluated must be typical of its peer group. Having only one or two characteristics in common with its peer group would not be considered typical of the group. For example, an institution may be of comparable size and within the same district, but may have completely different portfolio characteristics (such as loan size and enterprises financed).

Actual versus projected performance analysis--Used to measure institution performance at a point in time against what was planned for the period. As with peer group analysis, deviations may be an indication of weaknesses, but further analysis is needed.

Ratio analysis--Used to evaluate the relationship between two elements. For example, the return on assets ratio is a key measure of profitability and efficiency, indicating how well the institution is using resources (assets) to generate income. Ratio analysis can be used to analyze financial condition, as well as asset quality. In performing such an analysis, examiners should identify underlying causes for trends or fluctuations.

Summary--Regardless of the analytical method used, examiners should be alert to conditions that may influence the interpretation of data (particularly when a ratio or statistic appears to represent deviation from the norm). Some of the more frequent problems encountered in an analytical review include:

• Errors in the underlying data. Misinterpretation of reporting instructions, inadequate management information systems, improper accounting, and typographical errors are the most common causes of error in underlying data. Detection of some errors can be accomplished by review of the underlying reports. However, in some instances, more extensive review is needed.
  
• Changes in accounting treatment. Alternative accounting treatments for similar transactions may produce significantly different results. Therefore, such changes should be thoroughly investigated for appropriateness. Frequent changes in accounting treatment may indicate an attempt on the part of the institution to make its operating results appear more favorable than could be otherwise justified.
  
• Extraordinary transactions. Such transactions, particularly those affecting income and expense items, can produce significant shifts in operating ratios.
  
• Improper calculation of ratios or trends by the analyst. The method used for calculating ratios must be consistent and the data must be as of the same date.
  
• Lack of comparability with peer groups. As previously discussed, examiners must consider whether the institution is typical of its peer group.