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Bank Analysis of USAA

  1. Introduction

This paper is being prepared to analyze the financial performance and position of USAA for the for purpose of evaluating whether it could accomplish its declared mission and future direction as set by the Chief Executive Officer based on the company’s latest annual report.  Its profitability (Brigham and Houston, 2002) will be compared with the interest rates set by the Federal Reserve Board. Since the company is a bank, its main source of income should come from liquid assets such treasury bills issued by government and other short term investment so as to maintain balance to its liquidity which is necessary in its nature of business.

An access was made from either the US Securities and Exchange Commission or the company’s website to obtain the company’s balance sheet and income statement.  From the data given in the Consolidate Balance Sheet and Consolidated Income Statement and other data, the following are derived the following statements are prepared: a Statement of Cash Flows (Appendix A) and Common sized Financial Statements (Appendix B) and Financial Ratios (Appendix C).

Analysis and Discussion

2.1 Strengths and Weaknesses based on the above spreadsheets and the related information

Company’s strengths are capabilities that can be tapped by a company in its strategies in attaining its corporate objectives while weaknesses are those that may restrict the company to meet these objectives. These set of strengths may be viewed by evaluating profitability, liquidity and solvency (Meigs and Meigs, 1995) of the company.

 2.1.1 Profitability

Profitability is the primary goal of every business since its absence will result to the business not being able to survive both in the short run and in the long run. This is the basis for the need to measure current and past profitability as well us making projection of future profitability.

Profitability comes with income and expenses, where the income must be higher than expenses. If the opposite happens there is loss. To explain the relationship of the two accounts it must be stated that companies use assets and the result will expenses in providing goods or service. In the process of spending expenses by the use of assets, the company generates revenues or incomes which must exceed the amount of costs or expense to guarantee profits. Profitability is therefore determined in the income statement that would show more revenues over expenses.  From net income various ratios could be generated by dividing the same with total revenues, total assets and total equity to facilitate analysis

The company has a very high profitability level as evidence by the following net profit margins of 0.17, 0.12, 0.14 and 0.14 for the years 2006, 2005, 2004 and 2003 respectively after the same rates have further improved from the net profit margin of 0.05 and 0.07 for the years 2002 and 2001 respectively. It is clear that the last four years are greater the average for the past six years of 0.12.

The ratio means in practical terms that for every $100 worth of products or services rendered by the company, which are can be measured by the amount of loan granted or amount of insurance policies issue, the company stands to earn about $12.   Given the nature of its business it could be deduced that company is earning very high. Since net income and total revenues are used to measure the net margin ratio, there is a need to see whether the past behavior of revenues indicate growth.

The  vertical common size financial statements prepared show that the bulk of the company’s revenues are taken from insurance premiums from members which constituted not less at 68% of the total revenues for the for years 2006, 2005, 2004, 2003, 2002 and 2001. Since the company’s revenues essentially came from insurance then it is expected that the bulk from its expenses must also be related to insurance. Indeed the expectation is true as the great part of expenses in relation to total sales is on losses, benefit payments, and loss adjustment expenses accounts which are principally based on the claims of the insured members. (See Appendix B and Appendix A-1).

The same may be said about the company’s return on assets (ROA) at 0.04, 0.03, 0.03, 0.04, 0.01 and 0.02 for years 2006, 2005, 2004, 2003, 2002 and 2001 respectively. The company’s Return on Equity (ROE) at 0.18, 0.12, 0.16, 0.17, 0.06 and   0.08 for the same years  of 2006, 2005, 2004, 2003, 2002 and 2001 respectively further confirmed the company’s seeming established profitability.

The company has almost maintained high profitability in terms of the ratios for the past six years.   The higher ROE over the ROA is more beneficial to members as the benefits accrue to them more given the low level of ROA. There are therefore other avenues of enhancing better profitability by improving further management of company assets.

2.1.2 Liquidity

A company needs to be liquid in terms of its ratio of current or quick assets to current liabilities to be at least 1.0 (one). Such is an indication that the company is able to match currently maturing obligations.

In case of failure of a company to do the same then it is possible to have bankruptcy that may force it to stop operation. The explanation for this is obvious as the salaries of its employees which must come every payday cannot be kept longer than needed.  The fact it maintains deposit of clients and provides needs in case of contingency and emergency then its quick assets or current assets like cash, marketable securities, short term investments, and loans receivable must really be liquid.

The company has a weak liquidity position with the current ratios of  0.16, 0.29, 0.23, 0.34, 0.44 and 0.21 for the years 2006, 2005, 2004, 2003  and 2002 respectively See Appendix C.  Its average of 0.28 for the past six years indicate the company may suffer a liquidity problem since current assets of the company are not enough to pay currently maturing obligations.

The company’s liquidity of below 0.5 is therefore quite alarming if not remedied upon.

2.1.3 Solvency: 

Solvency is closely linked to liquidity as both are ways to determine the ability of an enterprise to meet its debts.  Liquidity however is for short term while solvency must be long term. Thus it is now more concerned about the financial stability of the company to survive in the long run, which is long enough to generate profitability to satisfaction of owners and creditors alike.  Solvency is a different concept from profitability, as the first refers to the ability of a company to earn a profit which may of course help the company to attain stability.

Solvency is normally measured using debt to equity ratio for which the company has exhibited and average of 3.6 for the past six years and it is still not too high given the nature of its business. See Appendix CGood solvency may therefore be considered as strength of USAA.

2.2. Analysis of the bank’s historical profitability with federal interest rates

The prevailing interests of the Federal Reserve Board under treasury constant maturities were reflected at 2.06%, 2.06%, 2.03%, 2.05% and 2.02% from February 11 through February 15, 2008. It has an average at 2.04% which is bigger than what the company pays in terms of interest rate of an average of 1% for the past six years. This means the bank could invest its money sure money making Treasury bill rates higher than it pay as average interest expense to depositors and other creditors.  The behavior of the federal interest rates under different maturities may be appreciated more in the following graph:

On the other hand the behavior of the latest interest rates from the Federal Reserved Board is depicted by the following graph:

It is clear that an almost 1% differential between Treasury Bill rate and the rate at which the company  is spending is indeed an encouraging condition for USAA.

2.3 Company’s announced mission and future direction as stated by the bank’s Chief Executive Officer and evaluation whether the bank is in a good financial position to achieve those objectives

The USAA’s declared mission is to facilitate financial security of its members, associates and their families by providing a full range of highly competitive financial products and services. The company also declares that in so doing its mission, it seeks to the provider of choice for the military community and it takes upon itself as responsibility to ensure the continuation of USAA as a world class company (Annual Report, 2006).

This researcher believes that the company is in a good financial position to achieve those objectives with the company’s profitable rates an average of 12% net profit margin and 13% return on equity for the past six years of its operation.  Given also the company’s stable debt to equity ratios which have reflected an average of 3.61 for past six years, the company has all the chances to attain its mission and future direction.

What will support its capacity to meet its objectives is its record of past success in the past. Since the net profit margin and return on equity as well as debt to equity ratios did changed significantly on annual basis for the past six years, it may be deduced that the company should have all the reason to sustain its past successes. A precaution is however emphasized that the company will have to improve and guard its weak liquidity (Droms, 1990). It can do the same by increasing its liquid assets and decreasing its investment in the non-current assets.

2.4 A forecast of the company’s profitability assuming Federal Reserve Board hold interest rate would appear as follows:

To forecast with the interest rates assumed to be constant is to assume also that USAA will also perform almost similarly under past conditions. The projected financial statements may be found then correspondingly in Appendix D. The total revenues are projected to increase using an average of 25% annual growth based on the experience of six years. (Appendix D). It must also be noted what the relationships of expenses to total revenues were based on historical experience.

This would therefore imply that should conditions change, then the projected financial profitability must also be revised accordingly. Although its could be assumed that old condition could influence the future, it must be made clear that companies operate within a wider business environment where they have competitors who are ready to take on their market shares or even their business.

  1. Conclusion:

It can be concluded that USAA has in fact exhibited remarkable financial performance of the past six years from 2001 through 2006 which may be a good indication that its targets via its mission to serve its members, future direction to provide a choice to military community  and  vision to continue as a world class company. The company has performed well under stable debt to equity for the same years and under an apparently weak liquidity. Thus it can logically concluded that USAA can sustain its life over the long term under almost the same terms subject to improving its liquidity and its ability to defend itself against external conditions which are not part of this paper.

Appendices:

Appendix A – Statement Cash Flows

Appendix A-1 Consolidated Income Statement and balance Sheet

Appendix B – Common sized Financial Statements (Vertical and Horizontal)

Appendix C – Financial Ratios

Appendix D – Projected Profitability of USAA

References:

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Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK

Droms (1990) Finance and Accounting for Non Financial Managers, Addison-Wesley Publishing Company, England

Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, UK

Federal Reserve (2008), Federal Reserve Statistical Release, H.15, Selected Interest Rates (Weekly)  http://www.federalreserve.gov/releases/h15/Current/, Accessed February 21,2008

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