Transcript Rose - Middle Tennessee State University

Chapter Six
Measuring and Evaluating the
Performance of Banks and Their
Principal Competitors
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Value of the Bank’s Stock

P0 

t0
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(1  r)
t
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Value of a Bank’s Stock Rises
When:
• Expected Dividends Increase
• Risk of the Bank Falls
• Market Interest Rates Decrease
• Combination of Expected Dividend
Increase and Risk Decline
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Value of Bank’s Stock if Earnings
Growth is Constant
P0 
D1
r -g
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Key Profitability Ratios in Banking
R eturn on Equity C apital (R O E) =
N et Incom e
T otal Equity C apital
R eturn on A ssets (R O A ) =
N et Incom e
T otal A ssets
Net Interest
Margin

Net Interest
Income
Total Assets
Net Noninteres
t Margin

Net Noninteres
t Income
Total Assets
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Key Profitability Ratios in
Banking (cont.)
Net Bank Operating
Margin

Total Operating
Revenues
Total Operating
Expenses
-
Total Assets
Earnings
Per Share (EPS) 
Net Income
Common
Equity
After Taxes
Shares Outstandin
Total Interest Income __ Total Interest Expense
Earnings Spread = Total Earning Assets
Total Interest Bearing Liability
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g
Breaking Down ROE
RO E = Net Incom e/ Total Equity Capital
RO A =
Net Incom e/Total Assets
Net Profit M argin =
Net Incom e/Total O perating Revenue
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x
Equity M ultiplier =
Total Assets/Equity Capital
Asset Utilization =
Total O perating Revenue/Total Assets
x
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ROE Depends On:
• Equity Multiplier
– Leverage or Financing Policies
• Net Profit Margin
– Effectiveness of Expense Management
• Asset Utilization
– Portfolio Management Policies
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Components of ROE for All
Insured U.S. Banks (1996-2005)
Year
2005
2004
2003
2002
2000
1998
ROE
12.68
13.27
15.04
14.11
13.53
13.51
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=
=
=
=
=
=
=
NPM
18.89
19.81
19.86
17.10
12.02
12.73
X
X
X
X
X
X
X
AU
6.93
6.51
6.95
7.60
9.48
9.11
X
X
X
X
X
X
X
EM
9.63
9.72
10.93
10.87
11.78
11.74
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A Variation on ROE
ROE =
Net Income

Pre-Tax Net Operating Income
T otal O perating R evenue
T otal Assets

Pre-Tax Net Operating Income
Total Operating Revenue
T otal Assets
T otal Equity C apital
R O E = T ax M anagem ent E fficiency 
E xpense C ontrol E fficiency 
A sset M anagem ent E fficiency 
Funds M anagem ent E fficiency
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
Breakdown of ROA
N et Interest Incom e
ROA =

N et N oninterest Incom e
T otal A ssets
-
T otal A ssets
P LL-S ecurity G ain(Losses)+T axes-E xtraord inary G ains
T otal A ssets
R O A = N et Interest M argin +
N et N oninterest M argin +
S pecial T ransactions A ffecting N et Incom e
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Bank Risks
• Credit Risk
• Liquidity Risk
• Market Risk
• Interest Rate Risk
• Operational Risk
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• Legal and
Compliance Risk
• Reputation Risk
• Strategic Risk
• Capital Risk
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Credit Risk
The Probability that Some of the
Financial Firm’s Assets Will Decline
in Value and Perhaps Become
Worthless
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Credit Risk Measures
•
•
•
•
•
•
•
Nonperforming Loans/Total Loans
Net Charge-Offs/Total Loans
Provision for Loan Losses/Total Loans
Provision for Loan Losses/Equity Capital
Allowance for Loan Losses/Total Loans
Allowance for Loan Losses/Equity Capital
Nonperforming Loans/Equity Capital
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Liquidity Risk
Probability the Financial Firm Will
Not Have Sufficient Cash and
Borrowing Capacity to Meet Deposit
Withdrawals and Other Cash Needs
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Liquidity Risk Measures
• Purchased Funds/Total Assets
• Net Loans/Total Assets
• Cash and Due from Banks/Total
Assets
• Cash and Government
Securities/Total Assets
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Market Risk
Probability of the Market Value of the
Financial Firm’s Investment Portfolio
Declining in Value Due to a Change
in Interest Rates
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Market Risk Measures
•
•
•
•
Book-Value of Assets/ Market Value of Assets
Book-Value of Equity/ Market Value of Equity
Book-Value of Bonds/Market Value of Bonds
Market Value of Preferred Stock and Common
Stock
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Interest Rate Risk
The Danger that Shifting Interest
Rates May Adversely Affect a Bank’s
Net Income, the Value of its Assets or
Equity
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Interest Rate Risk Measures
• Interest Sensitive Assets/Interest
Sensitive Liabilities
• Uninsured Deposits/Total Deposits
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Operational Risk
Uncertainty Regarding a Financial
Firm’s Earnings Due to Failures in
Computer Systems, Errors,
Misconduct by Employees, Floods,
Lightening Strikes and Similar Events
or Risk of Loss Due to Unexpected
Operating Expenses
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Legal and Compliance Risk
Risk of Earnings Resulting from Actions
Taken by the Legal System. This can
Include Unenforceable Contracts,
Lawsuits or Adverse Judgments.
Compliance Risk Includes Violations of
Rules and Regulations
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Reputation Risk
This is Risk Due to Negative Publicity that
can Dissuade Customers from Using the
Services of the Financial Firm. It is the
Risk Associated with Public Opinion.
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Capital Risk
Probability of the Value of the Bank’s
Assets Declining Below the Level of
its Total Liabilities. The Probability
of the Bank’s Long Run Survival
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Capital Risk Measures
• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets
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Other Goals in Banking
O perating Efficiency R atio =
T otal O perating Expenses
T otal O perating R evenues
Em ployee Productivity R atio =
N et O perating Incom e
N um ber of Full T im e-Equivalent Em ployees
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UBPR
• The Uniform Bank Performance
Report Provided by U.S. Federal
Regulators so that Analysts Can
Compare the Performance of One
Bank Against Another
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