CHAPTER 5
MEASURING AND EVALUATING BANK PERFORMANCE
Goal of This Chapter: To help the reader learn how to analyze and evaluate a bank's performance, especially its rate of return, efficiency, and risk exposure, from the data provided in bank financial statements.
Key Terms Prented in This Chapter
Bank Profitability Equity Multiplier
ROA Credit Risk
ROE Liquidity Risk
Efficiency Market Risk
Net Interest Margin Interest-Rate Risk
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Noninterest Margin Earnings Risk
Net Profit Margin Solvency Risk
Ast Utilization UBPR
Chapter Outline
I. Introduction: Performance Pressures Faced by Banks Today
II. Evaluating a Bank's Performance
A. Determining the Bank's Long-Range Objectives
B. Maximizing The Value of the Firm: A Key Objective for Any Bank
C. Profitability Ratios: A Surrogate for Stock Values
1. Key Profitability Ratios in Banking
2. Interpreting Profitability Ratios
3. Uful Profitability Formulas
4. Breaking Down Equity Returns for Clor Analysis
5. Break-Down Analysis of a Bank's Return on Asts
6. What a Breakdown of Bank Profitability Measures Can Tell Us
D. Measuring Risk in Banking
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1. Credit Risk
2. Liquidity Risk
3. Market Risk
4. Interest-Rate Risk
5. Earnings Risk
6. Solvency (or Default) Risk
7. Other Forms of Risk in Banking (Inflation Risk, Currency or
Exchange-Rate Risk, Political Risk, and Crime Risk)
E. Other Goals in Banking
III. The Impact of Bank Size on Performance
IV. Watching out for Size, Location and Regulatory Bias in Analyzing Bank Performance V. Using Financial Ratios and Other Analytical Tools to Track Bank Performance--The UBPR.
VI. Summary of the Chapter
Appendix to the Chapter - Improving Bank Performance Through Knowledge: Sources of Information for Bankers, Their Customers, and Bank Regulators
Concept Checks
5-1. Why should banks be concerned about their level of profitability and exposure to risk? Banks in the U.S. and most other countries are private business that must attract capital from the public to fund their operations. If profits are inadequate or if risk is excessive, they will have greater difficulty in obtaining capital and their funding costs will grow, eroding profitability. Bank stockholders, deposit
ors, and bank examiners reprenting the regulatory community are all interested in the quality of bank performance. The stockholders are primarily concerned with profitability as a key factor in determining their total return from holding bank stock, while depositors (especially large corporate depositors) and examiners typically focus on bank risk exposure.
5-2. What individuals or groups are likely to be interested in the aspects or dimensions of bank performance?
The individuals or groups likely to be interested in bank profitability and risk include other banks lending to a particular bank, borrowers, large depositors, holders of long-term debt capital issued by banks, bank stockholders, and the regulatory community.
5-3. What factors influence a bank's stock price?
A bank's stock price is affected by all tho factors affecting its profitability and risk exposure, particularly its rate of return on equity capital and risk to shareholder earnings. A bank can rai its stock price by creating an expectation in the minds of investors of greater earnings in the future, by lowering the bank's perceived risk exposure, or by a combination of increas in expected earnings and reduced risk.
5-4. Suppo that a bank is expected to pay an annual dividend of $4 per share on its stock in the current period and dividends are expected to grow 5 percent a year every year, and the minimum required return to equity capital bad on the bank's perceived level of risk is 10 percent. Can you estimate the current value of the bank's stock?
In this constant dividend growth rate problem the current value of the bank's stock would be: P o = D1 / (k – g) = $4 / (0.10 – 0.05) = $80.
5-5. What is return on equity capital and what aspect of bank performance is it suppod to measure?吸氧有什么好处
Return on equity capital is the ratio of Net Income After Taxes/Total Equity Capital. It reprents the rate of return earned on the funds invested in the bank by its stockholders.
5-6. Suppo a bank reports that its net after-tax income for the current year is $51 million, its asts total $1,444 million, and its liabilities amount to 926 million. What is its return on equity capital?
The bank's return on equity capital should be:
ROE = Net After Tax Income = $51 million = .098 or 9.8 percent
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Equity Capital $1,444 mill.-$926 mill.
5-7. What is return on asts and why is it important in banking?
Return on asts is the ratio of Net Income After Taxes/Total Asts. The rate of return cured on a bank's total asts indicates the efficiency of its management in generating net income from all of the resources (asts) committed to the institution.
5-8. A bank estimates that its total revenues from all sources will amount to $155 million and its total expens (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 asts? Is this ROA high or low? How could you find out?
The bank's return on asts would be:
ROA = Net After Tax Income = $155 mill. - $107 mill. = 0.0096 or 0.96 percent Total Asts $4,960 mill. + $52 mill.
The size of this bank's ROA should be compared with the ROA's of other banks similar in size and location to determine if this bank's ROA is high or low relative to the average for
comparable banks.
5-9. Why do bankers pay clo attention today to the net interest margin and noninterest margin? To the earnings ba and spread?
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 curity investments and the cost of its borrowed funds. If the NIM ris, loan and curity income must be rising or the average cost of funds must be falling or both. A declining NIM is undesirable becau the bank's interest spread is being squeezed, usually becau of rising interest costs on deposits and other borrowings.
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In contrast, the noninterest margin reflects the bank's spread between its noninterest income (such as rvice fees on deposits) and its noninterest expens (especially salaries and wages and overhead expens). For most banks the noninterest margin is negative. Management will usually attempt to expand fee income, while controlling cloly the growth of noninterest expens in order to make a negative noninterest margin as least negative as possible.
The earnings ba indicates the proportion of the bank's earning asts (loans, leas, and investm
ents) relative to its total asts. As competition increas, greater pressure is placed on the bank's management to maintain the quality and quantity of the earning asts. Additionally, the bank's managers typically will shift some of their emphasis to increasing noninterest income generated by fees.
The earnings spread measures the effectiveness of the bank's intermediation function of borrowing and lending money, which, of cour, is the bank's primary way of generating earnings. As competition increas, the spread between the average yields on asts and the average cost of liabilities will be squeezed, forcing the bank's management to arch for alternative sources of income, such as fees from various rvices the bank offers.
5-10. Suppo a banker tells you that his bank in the year just completed had total interest expens on all borrowings of $12 million and noninterest expen of $5 million, while interest income from earning asts totaled $16 million and noninterest revenues added to a total of $2 million. Suppo further that asts amounted to $480 million of which earning asts reprented 65 percent of total asts, while total interest-bearing liabilities amounted to 55 percent of the bank's total asts. See if you can determine this bank's net interest and noninterest margins and its earnings ba and earnings spread for the most recent year.
The bank's net interest and noninterest margins must be:
Net Interest = $16 mill. - $12 mill. Noninterest = $2 mill. - $5 mill.
Margin $480 mill. Margin $480 mill.
=.00833 = -.00625 The bank's earnings spread and earnings ba are:
Earnings = $16 mill. - $12 mill.
Spread $480 mill * 0.85 $480 mill. * 0.75
= .0392 -.0333
Earnings Ba = $480 mill. - $480 mill. * 0.15 = 0.85 or 85 percent
$480 mill.
5-11. What are the principal components of ROE and what do each of the components measure?
The principal components of ROE are:
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a. The net profit margin or net after-tax income to operating revenues which reflects the effectiveness of a bank's expen control program;
b. The degree of ast utilization or ratio of operating revenues to total asts which measures the effectiveness of managing the bank's asts, especially the loan portfolio; and,
c. The equity multiplier or ratio of total asts to total equity capital which measures a bank's u of leverage in funding its operations.
都图5-12. If a bank has an ROA of 0.80 percent and an equity multiplier of 12x what is its ROE? Suppo this bank's ROA falls to 0.60 percent. What size equity multiplier must it have to hold its ROE unchanged?
The bank's ROE is:
ROE = 0.80 percent *12 = 9.60 percent.
If ROA falls to 0.60 percent, the bank's ROE and equity multiplier can be determined from:
ROE = 9.60% = 0.60 percent * Equity Multiplier
Equity Multiplier = 9.60 percent = 16x.
0.60 percent
5-13. Suppo a bank reports net income after taxes of $12, before-tax net income of $15, operating revenues of $100, asts of $600, and $50 in equity capital. What is the bank's ROE? Tax-management efficiency indicator? Expen control efficiency indicator? Ast management efficiency indicator? Funds management efficiency indicator?
The bank's ROE must be:
ROE = 50
$12$ = 0.24 or 24 percent
Its tax-management, expen control, ast management, and funds management efficiency indicators are:
Tax Management = $12 Expen Control = $15
以物抵债协议Efficiency indicator $15 Efficiency Indicator $100
= .8 or 80 percent =.15 or 15 percent
Ast Management = $100 Funds Management = $600
Efficiency Indicator $600 Efficiency Indicator $50
