Michael Zhan

BMGT445 Section 0101

U.S. Bank of Washington Case Analysis

Performance Analysis

In order to discuss the U.S. Bank of Washington’s performance against its peers and

competitors, its parent company, U.S. Bancorp, must first be examined and analyzed. The U.S.

Bancorp is the largest financial services company of the Pacific Northwest. Its portfolio is well-

diversified in financial services, allowing the corporation to meet the financial needs of their

business clients and individuals. U.S. Bancorp’s bank services are provided by many different

business units under its operation. For example, the capital markets group provides services in

international banking, merchant banking and trade financing, and maintained banking

relationships with corporate clients with sales exceeding $100 million. Commercial and

residential real estate loans are serviced in ten western states by the real estate group. U.S.

Bancorp’s leasing group, with 35 sales offices throughout the United States, finance equipment

for businesses. The commercial banking business unit of U.S. Bancorp is divided into three

groups, one for each state in the primary market, and known as the U.S. Bank to the

consumers. Examples of strong performing state banks in the primary market include the U.S.

Bank of Oregon, the largest bank in the state in 1990, with 192 branches and 42% of the

banking deposit market share. In Northern California, the U.S. Bank was the third largest in

1990 with 40 branches and 4% of the banking deposit market share.

14% of the banking deposit market share. U.S. Bancorp’s aims to have a well-diversified

portfolio involving industry segments related to the U.S. Bank of Washington. It focuses on

improving asset quality and reducing the percentage of its non-performing assets. The U.S.

Bank of Washington is continuously achieving its targets under these categories; thus, the U.S.

Bank of Washington and U.S. Bancorp is in a healthy condition and performing much better

than all the other banks in the system. We also see this represented in many of the bank’s

financial statements and ratios. U.S. Bancorp’s return on assets is 1%, which is much better than

the return on assets of all other banks. The return on equity of U.S. Bancorp is 15.12%, which is

almost double than all other banks. Furthermore, U.S. Bancorp’s net income is $105.8 million,

up 22% from $123.9. These numbers demonstrate efficient management of the company in

terms of generating returns from its assets and equity. This has helped the bank achieve a

growth in its dividend per share as well as an increase in commercial loans as a percentage of

the total loan portfolio. U.S. Bancorp’s main source of capital, retained earnings, are also

improving with its sound performance.

Analysis of Bank Strategy and Loan Application

The U.S. Bank of Washington will need to decide if making a loan to Redhook Ale

Brewery will fit the bank’s portfolio and banking strategy. In order to make this decision, the

loan must improve revenue and the cash flow stream of U.S. Bank of Washington. It must also

fit within U.S. Bancorp’s overall stated goals of 1% Return On Assets and +15% Return On

Equity. It must also reduce the risk of outstanding or existing loan portfolios in terms of loan

sector concentration. The loan must also include a pricing structure with maturity and rate that
is appropriate for a deal of Redhook Ale’s size reflective of the company’s creditworthiness, the

loan collateral, and its strengths and weaknesses. A floating rate could be used as well as a fixed

rate. Redhook can also pay a higher upfront fee than the typical 1% to obtain a lower loan

percentage rate. Key covenants that set restrictions on the leverage and current ratios must

also be included in order to protect against spending on future capital improvements.

In order to determine whether or not U.S. Bancorp should make this loan application to

Redhook, the 5 C’s of Credit can be used to evaluate Redhook’s overall financial performance.

Character

Redhook is a strong competitor within its industry against imported European brands in

quality and freshness. It is a widely accepted company by local residents in its region.

Furthermore, the promising growth in the brewery industry for national products is attractive.

Compared with other breweries, Redhook absorbed the latest technologies from the German

company Anton Steinecker Maschinenfabrik GmbH. This improved their design of their state-of-

the-art brewing equipment and positioned Redhook as the most technically advanced craft

brewery in North America.

Capacity

The capacity of Redhook Ale Brewery is reflected in its development history and

financial statement ratios and numbers. The Brewery was founded in 1981 by Paul Shipman and

Gordan Bowker. After several years of expansion, it had become one of the largest brewing

companies and was approaching its goal to be the dominant brewery brand in the Northwest

Pacific and California regions. Although this is a good sign of Redhook’s growth, the bank should
measure the likelihood of Redhook paying back the loan by comparing the current assets to the

current liabilities (current ratio). From 1982 to 1989, the current ratio increased; however, this

ratio was lower than 1, indicating that Redhook may have some problems in meeting the loan’s

obligation. However, Redhook’s projected current ratio from 1990 to 1994 reflect stronger

numbers, with 9.7 in 1990, 7.0 in 1991, 1.5 in 1992, 2.7 in 1993, and 4.4 in 1994. Redhook’s

relatively low current ratio in 1992 but relatively high current ratio in 1990 can possibly be

explained by Redhook holding too much inventory which it could not sell and too much cash on

hand that was not utilized efficiently.

Capital

By looking at the balance sheet of Redhook between 1982 and 1989, liquidity ratios can

be calculated in order to assess the financial health of the company. The current ratios were .57

in 1982, .58 in 1983, .42 in 1984, .79 in 1985, .80 in 1986, .85 in 1987, .68 in 1988, and 1.18 in

1989. A possible explanation for the sudden increase of the current ratio from 1988 to 1989 is a

huge increase in inventory. Redhook’s liquidity ratio was lower than 1.0 before 1989 and lower

than 1.50 in 1989; thus, Redhook may not have had the ability to repay the loan according to

these numbers from their daily operations. However, the debt to capital ratio before 1990

shows a rate lower than 50% which may indicate that Redhook could have had the ability to

repay their debt.

Collateral

For collateral, the quick ratio can be used to see whether or not Redhook had enough

liquid assets to satisfy its liability needs. In 1987, Redhook had a quick ratio of .7, .3 in 1988, and
.5 in 1989. These low ratios indicate that Redhook would have had a tough time liquidating

their assets in case of bankruptcy. However, other resources that Redhook has at its disposal,

such as its security interest in inventory and accounts receivable have been used for collateral

to finance other loans.

Condition

Some conditions that Redhook needed to meet for the loan included the current ratio,

quick ratio, and ROE. The current ratio should be used by the bank in order to decide whether a

company is able to repay its loans when due. According to the data, Redhook’s current ratio

increased from .9 in 1987 to 1.2 in 1989. The basic benchmark that Redhook was required to

meet should be around two; thus, Redhook must either increase its current assets or reduce its

current liabilities to increase the current ratio. From the future projections, however, Redhook’s

current ratio does exceed the benchmark, so Redhook may be able to repay its loans. The quick

ratio is a more conservative ratio used to evaluate the ability of a company to repay its loans.

From future projections, it can be inferred that the quick ratio is too low. The bank needs to be

aware of this and make sure that Redhook prepares more cash on hand or other cash

equivalents to face any unexpected situations. Besides the current and quick ratio conditions

Redhook needs to meet, ROE must be improved. Redhook needs to increase their net profit by

increasing sales or reducing costs and expenses.

Decision

By using RAROC and certain assumptions, U.S. Bancorp can decide whether or not to

issue the loan to Redhook. At an interest rate of 13% of the 6.5 million loan, an interest
expense of 11.5% of 6.5 million, and a fee income with 30 basis points, the net income is

calculated to be $78,000. The ΔLN was calculated to be -629,687.5 with a duration of 3.1 years,

the expected maximum change in the loan rate due to a change in the credit risk premium of

3.5%, and 1+R to be 1.12. With these numbers, the RAROC calculated was 12.39%, well above

the RAROC benchmark of 10%.

For maturity and loan rate, the maturity was assumed to be 7 years with a loan rate of

13%. Using the formula below, the annual cash payment of Redhook can be calculated. PV =

CFn * (1+r)^n. PV = $6,500,000. R = 13%. N = 7. FV = 0. Thus, the payment calculated is

$1,469,720.23 annually. Furthermore, Redhook’s gross profit from 1990 to 1994 increased from

$1,297,317 to $14,229,189, indicating that Redhook should have enough funds to repay the

loan.

Although some of Redhook’s ratios reflect some inherent risk for being able to repay

their loans, the bank should look at Redhook’s overall performance. Redhook’s market for beer

has potential to expand. By taking advantage of this opportunity, Redhook was able to

capitalize and project huge improvements in financial numbers on their balance sheet and

income statement. Their sales performed quite well and could compete with popular

established brands, and has had a very good credit history with the bank. Redhook has always

repaid its loans on time, indicating a good management and executive team. Based on the

factors stated above, the bank should make the loan to Redhook.