1. Bank
Performance 20

2. Performance Evaluation of Banks
OUTLINE OF INCOME STATEMENT
Interest Income (from loans & investments)
Interest Expense
= Net Interest Income (spread or margin)
+ Non-interest Income
Non-interest Expense
Loan Losses (Bad Debt Expense)
+/- Security Gains/Losses
Income Tax
= Net Income

3. Exhibit 20.2

4. Ch 20, Problem (10e, p. 529; 11e, p.563) Managing in Financial Markets
INCOME STATEMENT FOR HAWAII BANK % of Avg Assets
Interest Income (from loans & invest.) ?%
Interest Expense ?%
= Net Interest Income (spread or margin) ?%
+ Non-interest Income ?%
Non-interest Expense ?%
Loan Losses (Bad Debt Expense) ?%
= Net Income before Tax ?%
Income Tax ?%
= Net Income ?%
ROA = (Net Inc / Avg Assets) = ?%
ROE = (Net Inc / Equity) ?% / ?% = ?% or ROE = ROA * (Avg Assets/Equity) = ?%

5. Performance Evaluation of Banks
Interest income and expenses
Gross interest income = interest income generated from all interest-bearing assets
Affected by market rates
Impacted by composition of bank assets (loans provide higher rate than liquid investments)
Gross interest expenses = interest paid on deposits and borrowed funds
Impacted by the composition of bank liabilities (demand accounts are less costly than time deposits)
Net interest income = gross interest income – interest expenses

7. Gross Interest Income/Expense

9. Performance Evaluation of Banks
Noninterest income and expenses
Noninterest income results from fees charged on services
Lockboxes, overdraft fees, ATM fees, banker’s acceptances fees, cashier check fees, foreign exchange transactions, investment banking and other advisory fees
Loan loss provision is a reserve account established in anticipation of future losses
Noninterest expenses include salaries, office equipment
Securities gains and losses

12. Performance Evaluation of Banks
Return on assets (ROA)
Net income as a percent of total assets Net Income / Total Assets = ROA
Usually lower for large banks (money center banks) because they obtain funds from large deposits (CDs) that pay higher interest rates. Small banks usually get funds from demand deposits (zero interest) and small savings accounts (low interest).

13. How to Evaluate a Bank’s Performance
Examination of Return on Assets (ROA)
Will usually reveal poor performance, but will not indicate the source of the problem
Possible reasons for a low ROA:
Excessive interest expenses (e.g too many CDs)
Low interest received on loans and securities
Too conservative with loans—excessive short-term securities
Insufficient noninterest income
Service fees too low (should raise NSF fees, etc.)
High provision for loans losses

14. Performance Evaluation of Banks
Return on equity (ROE)
The return on capital invested Net Income / Capital = ROE
ROE = ROA x leverage multiplier (inverse of capital ratio)
ROE for large banks has been lower than for small banks for the same reasons that their ROA has been lower

16. Exhibit 20.11 Breakdown of Performance Measures

17. Influence of Bank Policies and Other Factors on a Bank’s Income Statement

18. Zager Bank Example Example of Zager Bank Application:
Zager bank is a medium size bank
Aggressive management style can be viewed as risky due to limited collateral and cash flow situation.
The bank charges high interest rates on loans because the borrowers do not have alternative lenders.
Strategy was successful during strong economic conditions.
When economy weakened in 2008, borrowers had trouble repaying their loans.

19. Zager Bank Example

20. Risk Evaluation of Banks
No consensus measurement exists that would allow for comparison of various types of risk among all banks
Some analysts measure a firm’s risk by its beta, which measures the sensitivity of stock returns to the market as a whole, but
Beta ignores firm-specific characteristics
Examples: look up BofA (BAC) or Banner Bank (BANR).

21. Beta measures non-diversifiable risk

22. Betas During Financial Crisis
Feb-08 / Today 0.19 / ? (BAC - Bank of America) 1.14 / ? (C - Citibank) 0.5 / ? (JPM - JP Morgan Chase) 0.04 / ? (WFC - Wells Fargo) 1.17 / ? (BANR - Banner Bank)

23. History of U.S. Bank Failures
# of banks failed 3 in 2007
30 in 2008
148 in 2009
157 in 2010
92 in in in so far in 2014
See FDIC website for details

24. Bank Failures Historical reasons for bank failure
Fraud from poor internal controls
Embezzlement of funds
No separation of personnel duties—esp. at small banks
High loan default percentage
Excessive reliance on a specific industry (such as oil, defense, or agriculture) or a specific geographic location.
Recession periods
Liquidity crisis
Bank runs, panics
Loss of confidence of financial markets
Increased competition (very tight margins)
Under-capitalization / over-leverage (too much debt)

25. Bank Failures
Study by the Office of the Comptroller of the Currency reviewed 162 national banks that have failed since 1979 and found that:
81% did not have a loan policy or did not closely follow their policy
59 % did not use an adequate system to identify problem loans
63% did not adequately monitor key bank officers or departments
57% allowed one individual to make major corporate decisions
Since these are all controllable, must conclude major reason is poor management.