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CHAPTER FIVEMeasuring And Evaluating The
Performance Of Banks And Their Principal Competitors
The purpose of this chapter is to discover what analytical tools can be applied to a bank’s financial statements so that management and the public can identify the most critical problems inside each bank and develop ways to deal with those problems
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Value of the Bank’s Stock
0ttr) (1
)E(D P
t
0
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Value of a Bank’s Stock Rises When:
Expected Dividends Increase
Risk of the Bank Falls
Combination of Expected Dividend Increase and Risk Decline
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Value of Bank’s Stock if Earnings Growth is Constant
g -r
D P
1
0
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Key Profitability Ratios in Banking
CapitalEquity Total
TaxesAfter IncomeNet (ROE) CapitalEquity on Return
Assets Total
TaxesAfter IncomeNet (ROA) Assetson Return
Assets Total
IncomeInterest Net Margin Interest Net
Assets Total
Incomet NoninteresNet Margin t NoninteresNet
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Key Profitability Ratios in Banking (cont.)
Assets Total
Expenses Operating Total
- Revenues Operating Total
Margin OperatingBank Net
gOutstandin SharesEquity Common
TaxesAfter IncomeNet (EPS) SharePer Earnings
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Breaking Down ROE
N e t P ro fit M a rg in =N e t In com e /T o ta l O pe ra tin g R e ve n ue
A sse t U tiliza tio n =T o ta l O p era ting R eve n ue /T o ta l A sse ts
R O A =N e t In co m e /T ota l A sse ts
E q u ity M u lt ip lie r =T o ta l A sse ts /E q u ity C a p ita l
R O E = N e t In co m e / T o ta l E qu ity Ca p ita l
x
x
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
ROE Depends On:
Equity MultiplierLeverage or Financing Policies
Net Profit MarginEffectiveness of Expense Management
Asset UtilizationPortfolio Management Policies
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Components of ROE for All Insured U.S. Banks (1991-2002)
Year ROE = NPM X AU X EM2002 14.51 = 17.16 X 7.82 X 10.822000 14.48 = 12.20 X 9.32 X 12.741999 14.92 = 14.01 X 8.91 X 11.951997 11.94 = 13.32 X 8.86 X 11.941995 14.19 = 12.68 X 8.93 X 12.531993 15.13 = 13.47 X 8.87 X 12.661991 8.00 = 5.32 X 10.17 X 14.77
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Bank Risks
Credit RiskLiquidity RiskMarket RiskInterest Rate RiskEarnings RiskCapital Risk
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Credit Risk
The Probability that Some of the Bank’s Assets Will Decline in Value and Perhaps Become Worthless
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Credit Risk Measures
Nonperforming Loans/Total LoansNet Charge-Offs/Total LoansProvision for Loan Losses/Total LoansProvision for Loan Losses/Equity CapitalAllowance for Loan Losses/Total LoansAllowance for Loan Losses/Equity CapitalTotal Loans/Total Deposits
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Liquidity Risk
Probability the Bank Will Not Have Sufficient Cash and Borrowing Capacity to Meet Deposit Withdrawals and Other Cash Needs
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Liquidity Risk Measures
Purchased Funds/Total Assets
Net Loans/Total Assets
Cash and Due from Banks/Total Assets
Cash and Government Securities/Total Assets
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Market Risk
Probability of the Market Value of the Bank’s Investment Portfolio Declining in Value Due to a Rise in Interest Rates
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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
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Interest Rate Risk
The Danger that Shifting Interest Rates May Adversely Affect a Bank’s Net Income, the Value of its Assets or Equity
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Interest Rate Risk Measures
Interest Sensitive Assets/Interest Sensitive Liabilities
Uninsured Deposits/Total Deposits
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Earnings Risk
The Risk to the Bank’s Bottom Line – Its Net Income After All Expenses
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Earnings Risk Measures
Standard Deviation of Net Income
Standard Deviation of ROE
Standard Deviation of ROA
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
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Capital Risk Measures
Stock Price/Earnings Per Share
Equity Capital/Total Assets
Purchased Funds/Total Liabilities
Equity Capital/Risk Assets
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Other Forms of Risk in Banking
Inflation Risk
Currency or Exchange Rate Risk
Political Risk
Crime Risk
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Performance Indicators Related to Size 2002
Performance IndicatorsAll
Banks
Under $100 Mill.
$100 Mill. To $1 Bill.
$1 Bill. To $10
BillOver
$10 Bill.ROA 1.37 1.05 1.26 1.48 1.38ROE 14.85 9.55 12.89 14.69 15.57
Net Operating Margin/TA 1.33 1.03 1.25 1.45 1.33Net Interest Margin/EA 4.13 4.32 4.44 4.32 4.03
Net Noninterest Margin/EA -1.03 -2.57 -1.29 -0.68 -2.16Operating Exp./Operating Rev. 55.03 68.19 61.85 55.65 53.35
PLL/Net Charge Offs 127.22 123.08 151.26 173.24 118.51Net Charge Offs/Total Loans 1.10 0.28 0.37 0.82 1.34
ALL/Total Loans 1.87 1.44 1.45 1.81 1.99Noncurrent Assets + Real Estate/TA 0.96 0.88 0.75 0.73 1.04
Net Loans/TotalDeposits 87.61 72.37 78.92 89.10 90.25Equity Capital/TA 9.24 11.12 9.91 10.29 8.84
Yield on Earning Assets 6.32 6.84 6.85 6.51 6.15Cost of Funding Earning Assets 2.18 2.52 2.41 2.18 2.12