The first ratio to identify is the Net Non-core Funding Dependence ratio. As mentioned above, this ratio measures the extent to which you are funding longer term assets with non-core funding. The ratio is defined as non-core liabilities, less short-term investments divided by long-term assets.

1. What is the Net Non-core Funding Dependence ratio for 2004?
2. How does this compare to peer?
3. What is the trend?
• Answer to all three questions.

The next ratio to identify is the Loans to Assets ratio.

As you can see, this ratio has increased substantially, which historically is a reflection of lower liquidity. However, different institutions with similar ratios may have different liquidity ratings due to differences in how those banks are managed. For example, a mortgage lender that portfolios its credits and is growing rapidly will need higher liquidity ratios than a mortgage lender with a heavily utilized securitization program and limited growth prospects.

Additionally, banks with similar ratios may have different liquidity ratings because of the nature of their loan portfolios. For example, a bank that specializes in short-term construction financing may generate significant amounts of cash flow/liquidity each month from payoffs, whereas an agricultural lender at the beginning a growing season will receive little cash flow during a period when outstanding loan balances are expected to rise dramatically. While these banks may have similar liquidity ratios, their actual liquidity position and ratings could be very different due to foreseeable changes. Think about how principal and interest payments impact your bank's cash flow. Given your loan portfolio and growth plans, how should your liquidity ratios compare to a "peer bank"?

What are some other ways that different banks could have different liquidity positions despite having similar liquidity ratios?

• Cash flow from principal and interest payments could vary due to the types of loans on the balance sheet
• One bank may have existing relationships and procedures for loan sales
• One bank may have a large loan maturing
• One bank may be involved in securitizing credits for the bond markets
• One bank may have borrowing lines collateralized by the loan portfolio

All of these answers could dramatically impact liquidity/cash flow. And while the use of borrowings secured by the loan portfolio is typically regarded as a volatile source of funding, the Federal Financial Institutions Examination Council has stated that their usage would not necessarily be criticized, so long as the borrowing is reasonable and well managed. While these borrowings are not as cheap as most core deposits, they are not as expensive as brokered deposits and the lenders are typically very flexible with the terms - meaning management can match their characteristics with the loan portfolio the borrowings are supporting.

The point here is that your analysis should not be limited to reviewing ratios. Whether you use a cash flow analysis or not, you need to have a conscious assessment of the liquidity position that takes into account all of your sources and uses of funds. Each bank has different cash flows, growth patterns, and liquidity requirements to consider. Also, there are numerous external stimuli that can impact a bank's liquidity and these must be considered as well. One of the reasons banks have a large number of directors who are not bankers by trade is because of the fresh perspective that they provide. Try to utilize the knowledge you have gained in your personal and professional lives to help management understand what outside forces will impact your bank's liquidity position.

Let's try to apply some of the information above to First State Bank. Please read the bank's liquidity comment in the Report of Examination.

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