Description
It is time to present your findings to the CEO and Board of Directors of US Bank. Create an executive summary that details the strategic and financial planning that the bank will initiate to maintain a healthy and prudent growth plan.
Be sure to include:
Your recommendation to the executive management on how best to raise capital with supporting reasoning.
A discussion of analyzing performance metrics based on the balance sheet data.
Summarize your findings into an official recommendation on how the bank should pursue growth.
Capital Markets
Capital Markets
Nicole Wert
Rasmussen University
Money and Banking
Kenneth Ritz
05/20/22
2
Capital Markets
Capital Markets
I have been, acting as the analyst for US Bank (which is considered a regional
bank), studying through several options in order to help the company to expand its business. Some
of these, that I have been investigating include issuing stocks and bonds, securitizing loans, raising
the capital, and to attempt to start working globally. For US Bank to be able to accomplish these
items, they need to consider all the pros and cons for each item to determine if those options are a
good fit for the startup company.
In the decision-making process for the consideration of raising capital, the company needs
to make the major decision as to whether they plan to use equity or debt financing. Under the
category of equity financing is venture capital. Venture capital is the capital invested where there
is a substantial element of a risk, typically for either new or expanding businesses, The benefit
when it comes to raising the capital us that the money is therefore the companies to keep. If there
is a success, the company then is able to have a big win that results in developing quickly. On the
other hand of this situation, if there is a failure then the company goes down. Unlike with a bank
loan, we do not commit to repay capital funds (Gerber, 2015). If the company were to go under
than there is no risk to having investor debt to constantly be concerned about. Without Capital
funds, we must wait for a steady revenue stream before we hire additional staff or purchase
expensive equipment or technology (Gerber, 2015). If there was an additional $500,000 or $1
million, the company would have the opportunity to being to achieve reaching the next level. This
way can also connect the company with other business leaders (Gerber, 2015). Capitalists are
3
Capital Markets
successful businesspeople and tend to have contacts with other industry (Gerber, 2015). Due to the
fact that Capital Investors have a stake within the company’s success, it would really be in their
best interest to aid the network with others who may be able to support the business and help it
become more profitable. While it is not necessary to repay capital funds, the money comes with
strings attached. Investors give us money in exchange for an equity share in our company; this
dilutes the number of shares that we hold and can offer future shareholders (Gerber, 2015) It is
dependent upon the number of shares that were granted, that there is a potential to be giving the
investors the right to make controlling decisions regarding the company. Additionally, raising
capital is a vigorous process. Company founders often spend a significant amount of time
developing their offering, shopping it around, and dealing with various follow-up meetings
(Gerber, 2015). One of the essential negatives when trying to raise equity capital is that the
company needs to qualify. For venture capitalists, they tend to seek quickly growing companies
that have the promise of higher chances of either being acquired or going public within the next
few years. Typically, the entrepreneur will have to show that the first is in a fast-growing industry
and is more than able to compete in such an environment (Gerber, 2015).
Furthermore, another way for the company to raise money is with the issuance of common
stock. Once again, companies need to do their research to determine whether issuing preferred or
common stock is worthwhile. Common stock is a security that is a representation of ownership in
a corporation. The holders or common stock will elect the board of directors and take part in votes
on company policies. This form of ownership will typically yield high rates of return in the long
run. Issuing stock gives us the advantage of not owning to any money to investors because we are
not borrowing (Terzo, 2017) In doing this, there is no requirement for the company to make and
4
Capital Markets
payments for the money that is raised in this way. In addition, the rising value of the stock can
increase the credit rating which aides in making it easier to borrow money in the future. There is a
constant need to maintain the actions to shareholders which can provide the company with distinct
focus and profitability. If the company becomes financially destressed and starts bankruptcy, it has
the least obligation to common stock investors (Terzo, 2017). Bankruptcy has a negative
connotation, the one plus side is having fewer preferred creditors. In a bankruptcy, the hierarchal
structure is such that if there is any remaining capital, holders of a company’s debt or bonds should
be paid first among investors (Terzo, 2017). Preferred shareholders take priority over common
shareholders. In the wake of a bankruptcy, a company only needs to repay common stock investors
if there is additional money are repaying their other creditors and shareholders. Due to the fact that
we sell shares of the company to investors, we then have to answer to all of the actions that those
stakeholders may do. There’s a possibility that the company would need to release information to
investors that they might not want competing business to find out about. Since the investors own
a piece of the company, they have a right to ask explanations and justifications for the business
decisions and may have the right to vote on issues affecting the company, the way we gain and use
assets, and how we keep our records (Terzo, 2017). The company may also need to offer quarterly
or monthly dividends in order to provide an incentive for investors to take an interest in the
company. Another side effect of this is that the company needs to incorporate in order to sell stock,
which could in turn bring about tax consequences.
Issuing bonds is another thing for the company to look into. The investors agree to give a
certain amount of money to the company in exchange for periodic interest payments (Wong, 2015).
The loan amount is repaid to the investor when it reaches the maturity date. There are several
5
Capital Markets
advantages for the company to issue and sell bonds. In exchange for selling bonds, there’s an
agreement to pay interest to the investors in exchange for the use of their money. This interest is
considered to be tax deductible as an expense for the company. Further advantages for bonds is
that the company can issue them whenever they’re in need of money. This is very different from
stocks, where companies typically issue these only once due to the second offering of stock will
have a tendence to dilute the price of the share because of extra supply. Bonds also offer the
advantage of allowing us to borrow money only for the time we will need it (Wong, 2015). The
company can limit the amount of time they pay interest on bonds by keeping a short duration of
them. There are several disadvantages to this as well. The company has to pay interest on time to
their bondholders, including even in the company goes bankrupt. This differs from dividends in
which the company only has to pay when bankruptcy is declared. This can cause issues with cash
flow. An additional disadvantage when it comes to bonds is that they raise the amount of debt that
is shown in the financials and investors will typically look at debt in ways to determine if that
company looks desirable or unappealing to them. The company would need to have a good credit
rating if they want to continue using bonds in the future.
Securitization is the process where an issuer designs a marketable financial instrument by
merging or pooling various financial assets into all one group. The original issuer will then sell
this group of repackaged assets to the investors. In response, banks are starting to present
borrowers with a range of fee-earning services that promote the sale of debt instruments to
investors (Francis, 2014). Banks may then make the choice to agree to acquire only the unsold
portion of the issued debt. This, securitization, is starting to make banks move away from making
traditional banking functions. These include extending credit with the exchange for periodic
6
Capital Markets
interest payments. Securitization also provides the creditor with two specific benefits. The lender
can choose whether to trade the notes or hold them to maturity; the lender can better manage its
credit limits and asset portfolio (Francis, 2014). Additional benefits for the bank include gaining a
large part of it’s income on the underwriting facility from fees repaid for its services, rather than
from periodical interest payments (Francis, 2014). Securitization can be attractive to borrowers
due to the fact that it gives them raised financing flexibility. They are able to time the issuance of
their securities in order to match their financial needs. Also, more investors would be willing to
purchase debt securities than participate in directed or term loans. Meaning that borrowers have
more options for financing. The downside of securitization is that it can increase the legal issues
of the borrowers. As debt is issued in the form of tradable securities, debt issues are influenced by
relevant regulations as well as banking regulations (Francis, 2014).
Finally, there is the idea of going globally for the expansion of the business. As with all of
the other options mentioned there are pros and cons to do this as well. Doing business globally can
take the form of transporting, licensing, a joint venture or manufacturing, but whatever form we
choose, it is required to assess customer demand, gain legal and accounting compensation, protect
intellectual property and follow regulations (Brandongaille, 2015). On positive note that comes
from this is that going global can help broaden the horizons of the company. Being able to learn
from the global companies dealt with and the products and services that may not be available at
home. This will help to increase the recognition of the company and it’s services and products,
which aids in the continuation of expanding. Some of the cons include creating time issues, barrier
due to language, and the fluctuations in currency. The change in hours that the company would
need to be available can make things challenging. Language barriers can slow the business process.
7
Capital Markets
There are chances of fees involved with currency exchanges, most specifically with credit card
transactions that could take a hit to the profit margin.
Upon a complete evaluation of all of the above options, I believe that the easiest option
that would be best to pursue would be issuing stocks or bonds. The benefit, again, to issuing stocks
means that with allowing investors to buy shares of the company is that they own a piece of it. On
the other hand, issuing bonds would mean that the company is borrowing money from investors
and paying interest to them. Both of these methods could work with their own advantages and
disadvantages. It needs to be decided what’s best at the time for how the company is being run and
grown. Issuing stocks, unlike borrowing money, the company isn’t obligated to make monthly
payments to the stockholders.
I believe that for the executive management team the option they would lean most towards
is going globally. The advantages and disadvantages of expanding the business indicated that there
are some increased costs, but it’s also a great chance to meet increased profits. With the chance
that the market can absorb the costs of expansion and also nail down the international
manufacturing process, the company would easily be able to expand globally.
8
Capital Markets
References
Brandongaille. (2105, August 25). Retrieved from https://brandongaille.com/12-pros-and-consof-expanding-a-business-internationally/
Francis, A. (2014, March 17). The Pros and Cons of Securitization. Retrieved from
Gerber, S. (2015, May 21). Twelve Pros and Cons of Raising Money Vs. Bootstrapping.
Retrieved from https://mashable.com/20150/05/21/pros-cons-raising-money/#hdh5onpxHGql
Terzo, G. (2017, November 21). Pros & Cons of Investing in Bonds. Retrieved from
https://fifthperson.com/pros-cons-investing-bons/
Capital Markets
Capital Markets
Nicole Wert
Rasmussen University
Money and Banking
Kenneth Ritz
05/20/22
Proposed Capital Structure
2
A company’s capital structure is more important and complex than simply deciding what
debt-to-equity ratio will be chosen. Upper management’s goal should be to determine a capital
structure that maximizes stockholders’ wealth. The first Modigliani-Miller Theorem considered
in a world without taxes, capital structure did not affect a company’s value (Corporate Finance
Institute, 2020). Since such a world does not exist, M&M Proposition 2 was elaborated including
the effects of taxes. M&M Proposition 2 (M&M II) is one of the most important theories of
modern finances since it shows how the cost of equity is directly affected by the company’s
leverage. At the same time, a company may be able to make higher profits and obtain higher
returns on equity through higher leverage. But as financial leverage increases, so does the
company’s levered beta and the cost of equity. This theorem is expressed by the following
formula:
Re = Ra + (D/E)*(1 – Tc)*(Ra – Rd)
Where:
•
Re = cost of levered equity
•
Ra = cost of unlevered equity
•
Rd = cost of debt
•
D/E = Debt-to-equity ratio
•
Tc = corporate tax rate
How Does Capital Structure Affect Profits?
The advantage of using leverage to finance the company’s activities and projects is that
the after-tax cost of debt is usually much lower than the cost of equity. They are actually related
since a riskier corporation with high leverage will have a high cost of equity and that in turn will
Proposed Capital Structure
3
increase the cost of debt. For example, assuming a corporate tax rate = 21%, EBIT = $10,
interest-bearing debt of $20 at 8% interest rate, and $20 in equity:
Net income = ($10 – $1.6) * (1 – 21%) = $6.636
ROE = $6.636/$20 = 33.18%
But if the company is financed 100% using equity, then net income and ROE will be:
Net income = $20 * (1 – 21%) = $7.9
ROE = $7.9 / 40 = 19.75%
Even though profits are higher in the second scenario, the ROE is much lower. This is the
advantage of including debt in the capital structure.
How does Capital Structure Affect Cost of Equity
The problem with including debt in the capital structure is that it will increase the
company’s costs and operational risk. No company in the world can guarantee that it will make a
specific amount of profit and the risk of revenues decreasing or costs increasing is inevitable. As
stated by M&M II, as the debt-to-equity ration increases, so will the cost of equity. It is a
balancing act where upper management must choose how much risk they are willing to assume
without jeopardizing the company’s sustainability, and investors will ultimately decide how
much they are willing to pay for stocks with that level of risk. Taking no debt reduces risks since
no interest payments are due, but also reduces return on equity. Investors are risk averse, and
they will always require a higher return for higher risks (Ross et al., 2017).
Factors Affecting Gentry’s Capital Structure
Deciding a company’s capital structure is never easy and several factors must be
considered including total capital required ($50 million in this case), company’s operations, stage
of company development, industry, general economic conditions, etc. Gentry is currently trying
Proposed Capital Structure
4
to raise capital for an international expansion to China, Japan, and Germany. Expansion
strategies tend to be risky, so a debt-to-equity ratio higher than one would probably result in
stockholders demanding a higher return which results in lower stock prices. Another factor that
limits the amount of debt that the company can take is high inflation rates which are pushing
interest rates up. The FED has already announced that it will increase interest rates soon, so
taking debt will be more expensive (Smialek, 2022). Gentry is a high-tech firm, and it has the
potential to increase overall revenues and profits significantly over the next years. High-tech
firms have been growing at significantly higher rates than traditional companies, but they are
also riskier since new technologies can quickly become obsolete. This results in investors being
willing to purchase the company’s stocks but at the same time they will demand good financial
performance.
Recommendations
Considering all the factors that affect Gentry right now, I would recommend a capital
structure of 40% debt. High-tech firms have proven to be great investment opportunities and I
believe that there will be enough investors attracted by Gentry’s business model to raise $30
million in the IPO. Actually, Gentry could probably raise the whole $50, but that would also
decrease future returns on equity. The reason why investors like high-tech stocks is that they
have the potential to yield very high returns and having some leverage will help to increase the
company’s ROE. Defining an optimal capital structure always has some degree of uncertainty.
I’m convinced that Gentry will succeed in its international expansion and as it consolidates into a
major player in its industry, it will be able to increase its debt without negatively affecting stock
prices. This way, the company’s upper management will be able to maximize stockholders’
wealth.
Proposed Capital Structure
5
References
Corporate Finance Institute. (2020, February 26). M&A Document Retention.
https://corporatefinanceinstitute.com/resources/templates/word-templatestransactions/ma-document-retention-guide/
Ross, S., Westerfield, R., & Jordan, B. (2017). Essentials of Corporate Finance (9th ed.).
McGraw Hill.
Smialek, J. (2022, February 23). Fed Officials Firm Up Plans for Swift Pullback of Economic
Help. The New York Times.
Balance Sheet
Nicole Wert
Rasmussen University
Money and Banking
Kenneth Ritz
06/05/22
Balance Sheet
Balance sheet review: Describe US Bank assets and liabilities.
US Bank’s total asset are $556.5 billion and total interest-bearing liabilities are $307 billion.
Loans represent $312 billion, and Consumer and banking segments represent almost half of
outstanding loans. Non-interest-bearing deposits totaled $127 billion, while interest bearing
deposits totaled $307 billion. Equity increased by 41.6 billion to almost $54 billion during 2021
(U.S. Bancorp, 2022, p. 336).
The bank’s average earning assets increased during 2021 to $506.1 billion from $481.4 billion
during 2020. But this does not mean that the bank handed out more loans during 2021 since the
increase is due to higher investment securities since outstanding loans decreased (U.S. Bancorp,
2022, p. 223).
Bank’s assets are mostly loans that it issues and investment securities while liabilities are the
deposits that customers (organizations and individuals) have in the bank.
What forms of income does US Bank generate?
US Bank operates in the following business segments (U.S. Bancorp, 2022, p. 3-4):
1. Corporate and commercial banking. This segment contributes $1.6 billion to the bank’s
net profits (20.4%) and it includes the following services: corporate and commercial
lending, equipment finance and leases, depository services, treasury managements
services, international trade services, and capital market services. The bank generates
revenues by charging interest rates on the loans and leases it hands out and banking fees.
2. Consumer and business banking. This segment represents $2.3 billion of the company’s
net profits (or 28.5%) and it includes the following services: mortgage lending,
community banking, metropolitan banking, and indirect lending. In other words, this
segment includes all the services that the bank offers to individuals like checking
accounts, savings accounts, ATMs, etc., but it does not include loans. The banks
generates revenues through banking fees. It is the largest segment by profits.
3. Wealth management and investment services. This is the smallest segment by revenue
generating $837 million in profits (10.5%) but it is also probably the smallest segment of
the bank in terms of employees and allocated resources. This makes it probably the most
profitable segment. Its services are catered to wealthy individuals or families and the
bank provides private banking services, financial advisory, investment management,
brokerage, insurance, trust, custody and fund management services. The main source of
revenues are the banking fees charged for the services provided.
4. Payment services. This segment is related to the consumer and business banking service
since it includes credit and debit cards, purchasing card services, consumer lines of credit
and merchant payment processing services. This segment represents $1.7 billion in
profits (19%) generated mostly though interests charged and banking fees.
5. Treasury and corporate support. This segment includes services like investment
portfolios, capital management, funding, and interest rate risk management services. The
segment contributed $1.5 billion to the bank’s profits mainly through banking fees.
How can the bank optimize assets and liabilities?
The bank’s operations are highly regulated, and the FED requires that every bank has a minimum
amount of reserves to reduce liquidity risk. The bank makes money though loans or by providing
services with interest income being the highest source of revenue (U.S. Bancorp, 2022, p. 336).
Banks need to manage the allocation of loans in order to decrease risk associated to bad credit. I
believe that the bank is investing too heavily on securities that pay little interest (generally US
government) but it is a way to decrease operating risks. Right now, with the economy balancing
between falling into a recession or rebounding, it is hard to decide what is the best strategy.
Handing out more loans will increase the banks revenues but will also increase risk. It is
probably better to wait to see what happens with future interest rate hikes by the FED before
making any decision.
Discuss US Banks net interest margin, ROA, ROE, leverage, and bank leverage.
The following ratios were provided by US Bank (U.S. Bancorp, 2022, p. 228):
•
Return on average assets (ROA) is very low, only 1.43%, although it is an improvement
from 2020 when it was 0.93%. The bank manages a large amount of assets, so it is
normal that the ROA is very low. A ROA of 1.3% of more is considered good for a bank
(Ahern, 2017).
•
The bank’s return on average common equity (ROE) for 2021 was 16% which is a
significant increase from 2020’s 10%.
•
Total leverage for 2021 was 8.6 which is slightly higher than 2020’s 8.3 which means the
bank took a larger proportion of liabilities last year.
•
The leverage exposure 6.9 for 2021 which represents a decrease from 2020’s 7.3 meaning
that the bank has proportionally more equity.
What forms of risk does the bank face, and how can it mitigate those risks?
There are many risks that the bank faces and they are disclosed as risk factors under Economic
and Market Conditions Risk (U.S. Bancorp, 2022, p. 342-355):
•
Macroeconomic risk resulting from the Covid pandemic that affect the global economy
potentially leading to recessions, tighter credit conditions, credit losses, higher
unemployment, business bankruptcies, and significant business losses.
•
Changes in interest rates which might negatively affect outstanding debts and the volume
of future debts.
•
Security breaches, especially intentional data breaches by hackers.
•
Regulatory and legal risks in case the government changes banking regulations that could
potentially affect the bank’s business model in negative ways.
•
Credit and mortgage business risk in case the US economy fells into a recession.
•
Liquidity risk if the bank fails to manage its reserves adequately.
•
Competitive and strategic risk due to high industry rivalry and increasing competition.
•
Accounting and tax risk resulting from failed accounting and tax policies carried out by
the bank.
•
General risk factors resulting from unexpected events that the bank’s risk management
framework cannot properly address.
Describe how the Fed’s actions affect the daily business and planning outlook of US Bank?
US Bank and all banks are affected directly by the interest rates charged by the FED. The FED
lends depository institutions funds through a process known as “discount window” by which it
provides liquidity to reduce operating risks due to temporary cash shortages that may negatively
affect their reserves (Federal Reserve System, 2022). Besides the FED handing out loans, banks
also hand out loans to other banks which are known as overnight loans to meet reserve
requirements. The interest charged on overnight loans is the federal funds rate which is
“controlled” by the FED (Federal Reserve Bank of New York, 2022). These loans that are either
handed out by the FED or are unsecured borrowings made by federal entities determine the
interest rates charged by banks and paid to customers for their deposits. If the FED’s rates go up,
so will the interest rates charged and paid by banks. Lately, the FED has been increasing the
federal funds rate to try to slow down rising inflation which makes credit more expensive to
borrowers.
The US Treasury also sells or buys US government securities which affect the monetary base
through either expansionary or contractionary monetary policies. Contractionary monetary
policies involve selling US government securities to reduce the money supply in order to cool
down the economy and reduce inflation, while expansionary monetary policies result in buying
US government securities in order to increase the money supply and boost the economy (Federal
Reserve Bank of St. Louis, 2022).
References
Ahern, D. (2017). Return On Assets: How To Find Banks That Generate Profits. SeekingAlpha.
https://seekingalpha.com/article/4083227-return-on-assets-how-to-find-banks-generateprofits
Federal Reserve Bank of New York. (2022). Effective Federal Funds Rate – FEDERAL
RESERVE BANK of NEW YORK. New York Fed.
https://www.newyorkfed.org/markets/reference-rates/effr
Federal Reserve Bank of St. Louis. (2022). Expansionary and Contractionary Policy.
https://www.stlouisfed.org/in-plain-english/expansionary-and-contractionary-policy
Federal Reserve System. (2022). The Fed – Discount Window Lending. Federal Reserve.
https://www.federalreserve.gov/regreform/discount-window.htm
U.S. Bancorp. (2022). U.S. Bancorp Form 10-K. https://ir.usbank.com/static-files/f4e59eb65588-4451-bd99-34a3bec67769
Purchase answer to see full
attachment