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Asset Quality –Earnings Coverage

Published by slang April 25th, 2007 in Banks/Finan.Institutions, Ratio Analysis

To assess the Asset Quality of Banks/Financial Institutions, the following ratios need to be analyzed:

  1. Loans Loss
  2. Non-performing loans to total loans
  3. Loan Recoveries ratio
  4. Loan Loss Reserves
  5. EARNINGS COVERAGE
  6. Capital Adequacy
    1. Capital Formation Ratio
    2. Capital to Assets Growth
    3. Gross Capital to Average Assets plus Reserves

Ratio Purpose Formula
Earnings Coverage Ratio

  • Measures the level of earnings and the charge to income against the actual net charge offs and

  • Provides a measurement of the bank’s earnings cover to actual loan losses.

 Total Net Operating Income+ Provision for loan losses ———————— Net Write Offs
Illustration: Details of ABC Bank:

Net Operating Income for Year 2006 $8,000 m
Provision for Loan losses $1,000m
Net Loans Write Off $ 2,000m
Earning Coverage Ratio = 8,000/2,000= 4.0 times

Interpretation: For ABC Bank, its earning is adequate to cover the amounts written off.
The earnings coverage ratio is very important.Normally, when the earnings coverage is equal to or below 3 times, it’s high time to examine and determine the reason(s).

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