Presentation on theme: "Evaluating Bank Performance"— Presentation transcript:
1 Evaluating Bank Performance OutlineA Framework for Evaluating Bank PerformanceInternal PerformanceExternal PerformancePresentation of Bank Financial StatementsAnalyzing Bank Performance with Financial RatiosProfit RatiosRisk RatiosInternal Performance Evaluations Based on Economic ProfitRAROC (Risk-Adjusted Return on Capital)EVA (Economic Value Added)
2 A Framework for Evaluating Bank Performance Internal PerformanceBank planning (policy formulation)Goals, budgets, strategic planningTechnologyComputers, communications, paymentsPersonnel developmentChallenges (personal selling and geographic expansion)Job satisfaction (training and compensation)
3 A Framework for Evaluating Bank Performance External PerformanceMarket shareEarnings effectsRole of technologyRegulatory complianceCapitalLendingSecuritiesOtherPublic confidenceDeposit insurancePublic image
4 A Framework for Evaluating Bank Performance Presentation of Bank Financial StatementsBalance sheet (Report of Condition)Assets: cash assets, loans, and securitiesLiabilities: deposit funds and nondeposit fundsCapital: equity capital, subordinated notes and debentures, loan loss reservesIncome Statement (Report of Income)Interest incomeNoninterest incomeInterest expensesNoninterest expenses (including provision for loan losses)Net profit
5 A Framework for Evaluating Bank Performance Table 3.1 Balance Sheet for State Bank ($Thousands)ASSETS DEC. 31, DEC. 31, 1999Cash assets $ 9, $ 10,522Interest bearing bank balances ,000Federal funds sold , ,500U.S. Treasury and agency securities , ,848Municipal securities , ,616All other securitiesNet loans and leases , ,857Real estate loans ,Commercial loans , ,381Individual loans , ,640Agricultural loans , ,654Other loans and leases-domestic , ,025Gross loans and leases , ,675Less: unearned income reservesReserve for loan and lease losses , ,356Premises, fixed assets, and capitalized leases , ,398Other real estate , ,012Other assets , ,014Total assets $205, $183,767
6 A Framework for Evaluating Bank Performance Table 3.1 Balance Sheet for State Bank ($Thousands)LIABILITIES & CAPITAL DEC. 31, 2000 DEC. 31, 2001Demand deposits $ 23, $ 22,528All NOW and ATS accounts , ,322MMDA accounts , ,797Other savings deposits , ,992Time deposits<$100K , ,954Time deposits>$100K , ,665Total deposits , ,258Fed funds purchase and resaleOther borrowingsBankers’ acceptance and other liabilities , ,101Total liabilities , ,359Subordinated notes and debenturesAll common and preferred equity , ,408Total liabilities and capital $205, $183,767
7 Analyzing Bank Performance with Financial Ratios Profit ratiosRate of return on equityROE = NI/TE (net income after taxes/total equity)Rate of return on assetsROA = NI/TA (net income after taxes/total assets)Other profit measuresNet interest marginNIM = (Total interest income - Total interest expense)/Total assetsNote: municipal bond interest is not taxable, such that it must be grossed up to a pre-tax equivalent basis by dividing munis interest earned by the factor (1 - tax rate of bank).
8 Analyzing Bank Performance with Financial Ratios Profit ratiosUnraveling profit ratiosROE = ROA x TA/TE (total assets/total equity or equity multiplier).Thus, by decreasing equity, a bank can increase ROE based on any given level of ROA.ROE = NI/OR x OR/TA x TA/TE (where OR is operating revenue).The NI/OR ratio is the profit margin, while OR/TA reflects asset utilization. By using this breakdown, one can make inferences concerning the reason for say increases in ROE. If asset utilization and equity multiplier did not change, the profit margin must have increased due to cost savings pushing this ratio up.
9 Analyzing Bank Performance with Financial Ratios Risk ratiosCapitalizationLeverage ratioTotal equity/Total assetsTotal capital ratio(Total equity + Long-term debt + Reserve for loanlosses)/Total assetsNote: book values and market values likely are different and yield different results.
10 Analyzing Bank Performance with Financial Ratios Risk ratiosAsset qualityProvision for loan loss ratio= PLL/TL (provision for loan losses/total loans and leases)Loan ratio= Net loans/Total assetsLoss ratio= Net charge-offs on loans (gross charge-offs minusrecoveries)/Total loans and leasesReserve ratio= Reserve for loan losses (reserve for loan losses last yearminus gross charge-offs plus PLL and recoveries)/Totalloans and leasesNonperforming ratio= Nonperforming assets (nonaccrual loans and restructuredloans)/Total loans and leases
11 Analyzing Bank Performance with Financial Ratios Risk ratiosOperating efficiency (cost control)Wages and salaries/Total expensesFixed occupancy expenses/Total expensesLiquidityTemporary investments ratio= (Fed funds sold, short-term securities, cash, trading accountsecurities)/Total assetsVolatile liability dependency ratio= (Total volatile liabilities - Temporary investments)/Net loansand leasesNote: This ratio gives an indication of the extent to which “hot” money is being used to fund the riskiest assets of the bank.
12 Analyzing Bank Performance with Financial Ratios Other financial ratiosTax rate = Total taxes paid/Net income before taxesDollar gap ratio= Interest rate sensitive assets - Interest-rate sensitive liabilitiesTotal assetswhere rate-sensitive means short-term with maturities of less than one year (or repriced in less than one year).
13 Internal Performance Evaluations Based on Economic Profit RAROC (Risk-adjusted return on capital)ExampleCost of funds %Provision for loan lossesDirect expenseIndirect expenseOverheadTotal charges before capital charge 7.00%Capital charge*Total required loan rate %*Note: The capital charge is determined by multiplying the equity capital allocated to the loan times the opportunity cost of equity and then converting to a pre-tax level. Assume that the allocated equity to loan ratio is 10% and the opportunity cost of equity is 16%, such that the after-tax capital charge is 1.6%. If the tax rate for the bank is 0.3, the pre-tax capital charge is 1.6/( ), or 2.29.In this example, if the loan rate is 9.29%, the bank will earn the target return on equity of 16%. Of course, if the bank can price the loan at a rate higher than 9.29%, it will earn profit over the target level of equity returns. In this case an economic profit is earned in that the value of equity is increased.
14 Internal Performance Evaluations Based on Economic Profit EVA (Economic value added)= Adjusted earnings – Opportunity cost of capital,where adjusted earnings is net income after taxes, and the opportunity cost of capital equals the cost of equity times equity capital.RAROC and EVABoth methods are beneficial in assessing managerial performance and developing incentive compensation schemes compatible with shareholder wealth goals.RAROC has a short-run perspective (i.e., business unit profit is compared to the unit’s capital at risk)EVA has a long-run perspective (i.e., business unit profit is compared to the cost of capital of the bank)