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1、CHAPTER 6MEASURING AND EVALUATING THE PERFORMANCE OF BANKS AND THEIR PRINCIPAL COMPETITORSGoal of This Chapter： The purpose of this chapter is to discover what analytical tools can be applied to a banks financial statements so that management and the public can identify the most critical problems in
2、side each bank and develop ways to deal with those problems Key Topics in This Chapter 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 Performan
3、ceChapter OutlineI。Introduction：II。Evaluating a Banks PerformanceA。Determining Long-Range ObjectivesB。Maximizing The Value of the Firm： A Key Objective for Nearly All FinancialService InstitutionsC.Profitability Ratios: A Surrogate for Stock Values1.Key Profitability Ratios2。Interpreting Profitabili
4、ty RatiosD。Useful Profitability Formulas for Banks and Other Financial Service CompaniesE。Breaking Down Equity Returns for Closer AnalysisF。BreakDown Analysis of the Return on AssetsG.What a Breakdown of Profitability Measures Can Tell UsH.Measuring Risk in Banking and Financial Services1。Credit Ris
5、k2。Liquidity Risk3。Market Risk4.InterestRate Risk5.Operational Risk6。Legal and Compliance Risk7.Reputation Risk8。Strategic Risk9。Capital RiskI.Other Goals in Banking and Financial Services ManagementIII。Performance Indicators among Bankings Key CompetitorsIV。The Impact of Size on PerformanceA。Size,
6、Location and Regulatory Bias in Analyzing The Performance of Banks and Competing Financial InstitutionsB。Using Financial Ratios and Other Analytical Tools to Track Bank Performance-The UBPR。V。Summary of the ChapterAppendix to the Chapter Improving the Performance of Financial Firms Through Knowledge
7、: Sources of Information on the FinancialServices IndustryConcept Checks61。Why should banks and other corporate financial firms be concerned about their level of profitability and exposure to risk?Banks in the U。S。 and most other countries are private businesses that must attract capital from the pu
8、blic 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, depositors, and bank examiners representing the regulatory community are all intereste
9、d 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.62。What individual
10、s or groups are likely to be interested in these dimensions of performance for a bank or other financial institution？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 de
11、bt capital issued by banks， bank stockholders， and the regulatory community。63。What factors influence the stock price of a financialservices corporation?A banks stock price is affected by all those factors affecting its profitability and risk exposure， particularly its rate of return on equity capit
12、al and risk to shareholder earnings。 A bank can raise its stock price by creating an expectation in the minds of investors of greater earnings in the future, by lowering the banks perceived risk exposure， or by a combination of increases in expected earnings and reduced risk.64.Suppose that a bank i
13、s 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 based on the banks perceived level of risk is 10 percent. Can you estimate the current value of the
14、 banks stock？In this constant dividend growth rate problem the current value of the banks stock would be：Po = D1 / （k g） = $4 / (0.10 0。05） = 80。6-5。What is return on equity capital and what aspect of performance is it supposed to measure? Can you see how this performance measure might be useful to
15、the managers of financial firms?Return on equity capital is the ratio of Net Income/Total Equity Capital. It represents the rate of return earned on the funds invested in the bank by its stockholders. Financial firms have stockholders， too who are interested in the return on the funds that they inve
16、sted。66 Suppose a bank reports that its net income for the current year is $51 million， its assets totally $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 que
17、stion？The banks return on equity capital should be：ROE =Net Income =51 million= .098 or 9.8 percentEquity Capital$1，444 mill。-$926 mill。In order to evaluate the performance of the bank, you have to compare the ROE to the ROE of some major competitors or some industry average.67What is the return on
18、assets (ROA), and why is it important？ Might the ROA measure be important to bankings key competitors?Return on assets is the ratio of Net Income/Total Assets. The rate of return secured on a banks total assets indicates the efficiency of its management in generating net income from all of the resou
19、rces （assets） committed to the institution. This would be important to banks and their major competitors。68。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 eq
20、uity capital amounts to 52 million. What is the banks return on assets? Is this ROA high or low? How could you find out?The banks return on assets would be:ROA =Net Income=155 mill。 107 mill。= 0。0096 or 0。96 percentTotal Assets$4，960 mill。 + 52 mill。The size of this banks ROA should be compared with
21、 the ROAs of other banks similar in size and location to determine if this banks ROA is high or low relative to the average forcomparable banks。6-9。Why do the managers of financial firms often pay close attention today to the net interest margin and noninterest margin？ To the earnings spread?The net
22、 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 funds. If the NIM rises， loan and security income must be rising or
23、the average cost of funds must be falling or both. A declining NIM is undesirable because the banks interest spread is being squeezed, usually because of rising interest costs on deposits and other borrowings and because of increased competition today。In contrast, the noninterest margin reflects the
24、 banks spread between its noninterest income （such as service fees on deposits） and its noninterest expenses (especially salaries and wages and overhead expenses)。 For most banks the noninterest margin is negative. Management will usually attempt to expand fee income， while controlling closely the g
25、rowth of noninterest expenses in order to make a negative noninterest margin less negative.The earnings spread measures the effectiveness of the banks intermediation function of borrowing and lending money， which, of course， is the banks primary way of generating earnings。 As competition increases，
26、the spread between the average yields on assets and the average cost of liabilities will be squeezed， forcing the banks management to search for alternative sources of income, such as fees from various services the bank offers.6-10. Suppose a banker tells you that his bank in the year just completed
27、 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 of which earning assets repre
28、sented 85 percent of total assets， while total interest-bearing liabilities amounted to 75 percent of total assets。 See if you can determine this banks net interest and noninterest margins and its earnings base and earnings spread for the most recent year.The banks net interest and noninterest margi
29、ns must be：Net Interest =$16 mill. 12 mill。Noninterest=2 mill. - 5 mill。Margin480 mill。Margin480 mill。=。00833= -.00625The banks earnings spread and earnings base are:Earnings=16 mill.12 mill.Spread480 mill 0。85480 mill。 0。75= .0392=。0333Earnings Base=480 mill. $480 mill。 0。15=0.85 or 85 percent480 m
30、ill.611。 What are the principal components of ROE and what do each of these components measure？The principal components of ROE are:a。The net profit margin or net aftertax income to operating revenues which reflects the effectiveness of a banks expense control program;b。The degree of asset utilizatio
31、n or ratio of operating revenues to total assets which measures the effectiveness of managing the banks assets, especially the loan portfolio； and，c.The equity multiplier or ratio of total assets to total equity capital which measures a banks use of leverage in funding its operations。612。Suppose a b
32、ank has an ROA of 0.80 percent and an equity multiplier of 12x. What is its ROE？ Suppose this banks ROA falls to 0.60 percent。 What size equity multiplier must it have to hold its ROE unchanged？The banks ROE is：ROE = 0。80 percent 12 = 9。60 percent。If ROA falls to 0.60 percent, the banks ROE and equi
33、ty multiplier can be determined from：ROE = 9.60 = 0.60 percent * Equity Multiplier Equity Multiplier = 9。60 percent = 16x。 0.60 percent6-13.Suppose a bank reports net income of $12， beforetax net income of 15, operating revenues of $100， assets of 600， and 50 in equity capital。 What is the banks ROE
34、？ Tax-management efficiency indicator？ Expense control efficiency indicator？ Asset management efficiency indicator？ Funds management efficiency indicator?The banks ROE must be：ROE = = 0.24 or 24 percent Its taxmanagement, expense control， asset management， and funds management efficiency indicators
35、are:Tax Management=$12Expense Control=15Efficiency indicator$15Efficiency Indicator100= 。8 or 80 percent=。15 or 15 percentAsset Management=$100Funds Management=600Efficiency Indicator600Efficiency Indicator50= 0。1666 or 16。67 percent= 12 x614.What are the most important components of ROA and what as
36、pects of a financial institutions performance do they reflect？The principal components of ROA are:a。 Total Interest Income Less Total Interest Expense divided by Total Assets， measuring a banks success at intermediating funds between borrowers and lenders；b. Provision for Loan Losses divided by Tota
37、l Assets which measures managements ability to control loan losses and manage a banks tax exposure；c。 Noninterest Income less Noninterest Expenses divided by Total Assets， which indicates the ability of management to control salaries and wages and other noninterest costs and generate tee income；d。 N
38、et Income Before Taxes divided by Total Assets， which measures operating efficiency and expense control； ande。 Applicable Taxes divided by Total Assets， which is an index of tax management effectiveness。615。If a bank has a net interest margin of 2.50， a noninterest margin of -1.85%， and a ratio of p
39、rovision for loan losses, taxes, security gains， and extraordinary items of 0.47， what is itsROA?The banks ROA must be：ROA = 2。50 percent 1。85 percent 0。47 percent = 0.18 percent616.To what different kinds of risk are banks and their financialservice competitors subjected today?a。 Credit Risk - the
40、probability that loans and securities the bank holds will not pay out as promised。b. Liquidity Risk - the probability the bank will not have sufficient cash on hand in the volume needed precisely when cash demands arise.c. Market Risk - the probability that the value of assets held by the bank will
41、decline due to falling market prices.d. InterestRate Risk - the possibility or probability interest rates will change， subjecting the bank to lower profits or a lower value for the firms capital。e. Operational Risk the uncertainly regarding a financial firms earnings due to failures in computer syst
42、ems， employee misconduct, floods， lightening strikes and other similar events.f。 Legal and Compliance Risk the uncertainty regarding a financial firms earnings due to actions taken by our legal system or due to a violation of rules and regulationsg. Reputation Risk the uncertainty due to public opin
43、ion or the variability in earnings due to positive or negative publicity about the financial firmh。 Strategic Risk the uncertainty in earnings due to adverse business decisions， lack or responsiveness to changes and other poor decisions by managementi。 Capital Risk the risk that the value of the ass
44、ets will decline below the value of the liabilities。 All of the other risks listed above can affect earnings and the value of the assets and liabilities and therefore can have an effect on the capital position of the firm。617。What items on a banks balance sheet and income statement can be used to me
45、asure its risk exposure？ To what other financial institutions do these risk measures apply?There are several alternative measures of risk in banking and financial service firms. Capital risk is often measured by bank capital ratios， such as the ratio of total capital to total assets or total capital
46、 to risk assets。 Credit risk can be tracked by such ratios as net loan losses to total loans or relative to total capital. Liquidity risk can be followed by using such ratios as cash assets to total assets or by total loans to total assets。 Interestrate risk may be indicated by such ratios as intere
47、st-sensitive liabilities to interest-sensitive assets or the ratio of moneymarket borrowings to moneymarket assets. 6-18.A bank reports that the total amount of its net loans and leases outstanding is $936 million， its assets total 1,324 million， its equity capital amounts to 110 million， and it holds $1,150 million in deposits， all expresse