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    Chapter Six: Measuring and Evaluating The Performance of Banks and Their Principal Competitors

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    Abdelnasir Haider

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    Chapter Six: Measuring and Evaluating The Performance of Banks and Their Principal Competitors

    Uploaded by

    Abdelnasir Haider
    307 views32 pages

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    Copyright:

    © All Rights Reserved
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    Download as ppt, pdf, or txt
    307 views32 pages

    Chapter Six: Measuring and Evaluating The Performance of Banks and Their Principal Competitors

    Uploaded by

    Abdelnasir Haider

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 32

    Chapter Six

    Measuring and Evaluating the


    Performance of Banks and
    Their Principal Competitors

    McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
    6-2

    Key Topics

    • Stock Values and Profitability Ratios


    • Measuring Credit, Liquidity, and Other Risks
    • Measuring Operating Efficiency
    • Performance of Competing Financial Firms
    • Size and Location Effects
    • The UBPR and Comparing Performance

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-3

    Value of the Bank’s Stock

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-4

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-5

    Value of Bank’s Stock if Earnings Growth


    is Constant

    D1
    P0 
    r-g

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-6

    Key Profitability Ratios in Banking


    Net Income
    Return on Equity Capital (ROE) =
    Total Equity Capital
    Net Income
    Return on Assets (ROA) =
    Total Assets
    (Interestincome
    - Interestexpense) Net InterestIncome
    Net InterestMargin  
    T otalAssets T otalAssets

    Noninterest revenue
    - PLLL
    - Noninterest expenses Net Noninterest Income
    Noninterest Margin 
    NetMcGraw-Hill/Irwin 
    © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e T otalReserved.
    Assets T otalAssets
    6-7

    Key Profitability Ratios in Banking (cont.)

    Total Operating Revenues -


    Total Operating Expenses
    Net Bank Operating Margin 
    Total Assets

    Net IncomeAfterT axes


    EarningsPer Share (EP S) 
    CommonEquity Shares Outstanding

    Total Interest Income __ Total Interest Expense


    Earnings Spread = Total Earning Assets Total Interest Bearing Liability

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-8

    Breaking Down ROE

    ROE = Net Income/ Total Equity Capital

    ROA = Equity Multiplier =


    Net Income/Total Assets x Total Assets/Equity Capital

    Net Profit Margin = x Asset Utilization =


    Net Income/Total Operating Revenue Total Operating Revenue/Total Assets
    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e Reserved.
    6-9

    ROE Depends On:


    • Equity Multiplier=Total assets/Total equity capital
    ▫ Leverage or Financing Policies: the choice of
    sources of funds (debt or equity)

    • Net Profit Margin=Net income/Total operating


    revenue
    ▫ Effectiveness of Expense Management (cost
    control)

    • Asset Utilization=Total operating revenue/Total


    assets
    ▫ Portfolio Management Policies (the mix and yield
    on assets)
    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e Reserved.
    6-10

    Determinants of
    ROE in a
    Financial Firm

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-11

    Components of ROE for All Insured U.S.


    Banks (1992-2007)

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-12

    A Variation on ROE
    Net Income Pre-Tax Net Operating Income
    ROE =  
    Pre-Tax Net Operating Income Total Operating Revenue
    Total Operating Revenue Total Assets

    Total Assets Total Equity Capital
    ROE = Tax Management Efficiency 
    Expense Control Efficiency 
    Asset Management Efficiency 
    Funds Management Efficiency
    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e Reserved.
    6-13

    Breakdown of ROA

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-14

    Quick Quiz
    • What individuals or groups are likely to be
    interested in the banks’ level of profitability
    and exposure to risk?
    • What are the principal components of ROE, and
    what does each of the these components
    measure?
    • Suppose a bank has an ROA of 0.80% and an
    equity multiplier of 12x. What is its ROE?
    Suppose this bank’s ROA falls to 0.60%. What
    size equity multiplier must it have to hold its
    ROE unchanged?
    • What are the most important components of
    ROA and what aspects of a financial
    institution’s performance do they reflect?
    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e Reserved.
    6-15

    Bank Risks

    • Credit Risk • Legal and


    • Liquidity Risk Compliance Risk
    • Market Risk • Reputation Risk
    • Interest Rate Risk • Strategic Risk
    • Operational Risk • Capital Risk

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-16

    Credit Risk

    The Probability that Some of the


    Financial Firm’s Assets Will
    Decline in Value and Perhaps
    Become Worthless

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-17

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-18

    Liquidity Risk

    Probability the Financial Firm Will


    Not Have Sufficient Cash and
    Borrowing Capacity to Meet
    Deposit Withdrawals and Other
    Cash Needs

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-19

    Liquidity Risk Measures


    • Purchased Funds/Total Assets
    • Net Loans/Total Assets
    • Cash and Due from Banks/Total
    Assets
    • Cash and Government
    Securities/Total Assets

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-20

    Market Risk: Comprises Price Risk


    and Interest Rate Risk

    Probability of the Market Value of the


    Financial Firm’s Investment Portfolio
    Declining in Value Due to a Change in
    Interest Rates

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-21

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-22

    Interest Rate Risk

    The Danger that Shifting Interest


    Rates May Adversely Affect a Bank’s
    Net Income, the Value of its Assets
    or Equity

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-23

    Interest Rate Risk Measures

    • Interest Sensitive Assets/Interest


    Sensitive Liabilities

    • Uninsured Deposits/Total Deposits

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-24

    Off-Balance-Sheet Risk
    The Volatility in Income and Market Value of
    Bank Equity that May Arise from
    Unanticipated Losses due to OBS Activities
    (activities that do not have a balance sheet
    reporting impact until a transaction is
    affected)

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-25

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-26

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-27

    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.

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-28

    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

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-29

    Capital Risk Measures

    • Stock Price/Earnings Per Share


    • Equity Capital/Total Assets
    • Purchased Funds/Total Liabilities
    • Equity Capital/Risk Assets

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-30

    Other Goals in Banking


    Total Operating Expenses
    Operating Efficiency Ratio =
    Total Operating Revenues

    Net Operating Income


    Employee Productivity Ratio =
    Number of Full Time-Equivalent Employees

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-31

    Performance Indicators Related to


    the Size of a Firm, 2007

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights


    Bank Management and Financial Services, 7/e Reserved.
    6-32

    Appendix: UBPR
    The Uniform Bank Performance
    Report Provided by U.S. Federal
    Regulators so that Analysts Can
    Compare the Performance of One
    Bank Against Another

    Web link for UBPR and BHCPR:


    www.ffiec.gov
    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights
    Bank Management and Financial Services, 7/e Reserved.

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