Chapter Six Measuring and Evaluating the Performance of Banks and Their Principal Competitors.
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1 Chapter SixMeasuring and Evaluating the Performance of Banks and Their Principal Competitors
2 Key Topics Stock Values and Profitability Ratios Measuring Credit, Liquidity, and Other RisksMeasuring Operating EfficiencyPerformance of Competing Financial FirmsSize and Location EffectsThe UBPR and Comparing Performance
3 Why should banks be concerned about profitability and risk? Profitability and risk are the most important dimensions of performance. Banks are private businesses that must attract capital from the public to fund their operations.Bank stockholders, depositors, and bank examiners representing the regulatory community are all interested in the quality of bank performance.
4 Who is likely to be interested in these dimensions of performance? The individuals or groups likely to be interested in bank profitability and risk are:Other banks lending to a particular bank,large depositors,holders of long-term debt capital issued by banks,bank stockholders, and the regulatory community.
10 Key Profitability Ratios in Banking (cont.) Total Interest Income __ Total Interest ExpenseEarnings Spread = Total Earning Assets Total Interest Bearing Liability
11 ROESuppose a bank reports that its net income for the current year is $51 million, its assets total $1,144 million, and its liabilities amount to $926 million. What is its return on equity capital? Is the ROE you have calculated good or bad? What information do you need to answer this last question?
12 ROA – indicates efficiency in generating income from its assets A bank estimates that its total revenues will amount to $155 million and its total expenses (including taxes) will equal $107 million this year. Its liabilities total $4,960 million while its equity capital amounts to $52 million. What is the bank's return on assets? Is this ROA high or low? How could you find out?
13 Net interest and non-interest margins The net interest margin (NIM) indicates how successful the bank has been in borrowing funds from the cheapest sources and in maintaining an adequate spread between its returns on loans and security investments and the cost of its borrowed fundsIn contrast, the noninterest margin reflects the banks spread between its noninterest income (such as service fees on deposits) and its noninterest expenses (especially salaries and wages and overhead expenses).
14 Net interest and non – interest margins Suppose a banker tells you that his bank in the year just completed had total interest expenses on all borrowings of $12 million and noninterest expense of $5 million, while interest income from earning assets totaled $16 million and noninterest revenues added to a total of $2 million. Suppose further that assets amounted to $480 million. See if you can determine this bank's net interest and noninterest margins.
16 ROE Depends On: Equity Multiplier = Assets/Equity Leverage or Financing PoliciesNet Profit Margin= Net Income/Total Operating revenueEffectiveness of Expense ManagementAsset Utilization = Total operating revenue/Total AssetsPortfolio Management Policies
17 Components of ROE for All Insured U.S. Banks (1996-2005)
18 ROE/ROA ProblemSuppose a bank has an ROA of 0.80 percent and an equity multiplier of 12x. What is its ROE? Suppose this bank's ROA falls to 0.60 percent. What size equity multiplier must it have to hold its ROE unchanged?
20 Bank Risks Credit Risk Legal and Compliance Risk Liquidity Risk Market RiskInterest Rate RiskOperational RiskLegal and Compliance RiskReputation RiskStrategic RiskCapital Risk
21 Credit RiskThe Probability that Some of the Financial Firm’s Assets Will Decline in Value and Perhaps Become Worthless
22 Credit Risk Measures Nonperforming Loans/Total Loans Net Charge-Offs/Total LoansProvision for Loan Losses/Total LoansProvision for Loan Losses/Equity CapitalAllowance for Loan Losses/Total LoansAllowance for Loan Losses/Equity CapitalNonperforming Loans/Equity Capital
23 Liquidity RiskProbability the Financial Firm Will Not Have Sufficient Cash and Borrowing Capacity to Meet Deposit Withdrawals and Other Cash Needs
24 Liquidity Risk Measures Purchased Funds/Total AssetsNet Loans/Total AssetsCash and Due from Banks/Total AssetsCash and Government Securities/Total Assets
25 Market RiskProbability of the Market Value of the Financial Firm’s Investment Portfolio Declining in Value Due to a Change in Interest Rates
26 Market Risk Measures Book-Value of Assets/ Market Value of Assets Book-Value of Equity/ Market Value of EquityBook-Value of Bonds/Market Value of BondsMarket Value of Preferred Stock and Common Stock
27 Interest Rate RiskThe Danger that Shifting Interest Rates May Adversely Affect a Bank’s Net Income, the Value of its Assets or Equity
29 Operational RiskUncertainty 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
30 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
31 Reputation RiskThis 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.
32 Capital RiskProbability 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
33 Capital Risk Measures Stock Price/Earnings Per Share Equity Capital/Total AssetsPurchased Funds/Total LiabilitiesEquity Capital/Risk Assets
35 Calculate as many risk measures as you can from the following data Net loans and leases book value = $936Total assets = $1324 millEquity capital book value =$ 110 millDeposits book value = $1150 millMarket value assets = $1443 millMarket value of equity cap = $130 millCurrent stock price = $60 with annual per share earnings of $2.50Uninsured deposits = $243 millMoney market borrowings = $132 millNon performing loans = $43 millLoans charged off = $21 mill
36 solution Net loans and leases/total assets = 936/1324 Equity capital/total assets = 130/1443Uninsured deposits/total deposits = 243/1150Stock price/EPS = 60/250Non performing assets/net loans and leases 43/936Charge offs of loans/total loans and leases= 21/936Purchased funds /total liabilities = /Book value of assets/market value of assets = 1324/1443
37 UBPRThe Uniform Bank Performance Report Provided by U.S. Federal Regulators so that Analysts Can Compare the Performance of One Bank Against Another