Reference no: EM133433283

Petite Rock Bank

Petite Rock Financial Corp. (aka. PRF) is a bank holding company with a 100% owned subsidiary called Petite Rock Savings & Loan Association (aka. PR Bank). Incorporated in Delaware, but based in Newport Beach, California, PRF provides a full range of financial services to individual and corporate customers primarily in California, but mostly uses local deposits to fund single-family (aka. "one-to-four unit") residential mortgages in Southern California. As a result, single-family residential loans often account for more than 80% of Downey's total assets over the last two decades. Housing price has been rising fast in Southern California between 1995 and 2006, and PRF chose to specialize in one type of non-conventional mortgages, called pay-option adjustable rate mortgage (ARM). Pay-option ARM gives borrower freedom to decide how much to pay during an initial period of the loan: an option ARM borrower can choose to pay only interest in the first 2-3 years. For example, if one experiences temporary financial difficulty, the borrower can choose to pay only partially the monthly interest and capitalize the unpaid interest, until when the loan-to-value (LTV) ratio reaches 110% and a mandatory payment schedule will be imposed upon the borrower. PRF is a successful and dominant player in the pay-option ARM market in the Southern California: In its single-family loan book, its option ARM loans account for 91% by the end of 2005.

Required: 

1. Please perform analytical procedures and highlight risky accounts from the balance sheet and income statement for future audit work (You can use trend analysis, ratio analysis or vertical analysis. In your trend analysis, please focus on the financial statements for FY 2006 and FY2007 and mark out accounts that have experienced year-over-year change above 70%. Please comment on your trend analysis results with respect to the following accounts on the balance sheet ("Allowance for loan losses", "real estate acquired in settlement of loans/REO-real estate owned by banks"), on the income statement ("provision for credit losses"), and on the cash flow statement ("Loans originated and purchased for sale", and "proceeds from sales of loans held for sale"). 
2. The professor has introduced you to some basic accounting ratios for banks. Please ensure that you at least cover ROE, net interest margin, and leverage ratios for FY 2005, FY 2006 and FY2007. Comment on their trend over years. 
3. In mid-2007, your family heard from grapevine in your neighborhood that people who had large deposits at PR bank were slowly shifting their deposits to other large national banks. Your mother was not convinced, but asked for a quick investigation. She complained that she paid for your 1 year MSA tuition and you still had not analyzed one complete set of financial statements. Please cite numbers from all documents available to prove the value of your business education (with brief explanations) and address her concern.