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1、 47 CHAPTER 5 MEASURING AND EVALUATING THE PERFORMANCE OF BANKS AND THEIR PRINCIPAL COMPETITORS Goal 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 proble
2、ms inside 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 Perfor
3、mance Chapter Outline I.Introduction:II.Evaluating a Banks Performance A.Determining the Banks Long-Range Objectives B.Maximizing The Value of the Firm:A Key Objective for Nearly All Financial-Service Institutions C.Profitability Ratios:A Surrogate for Stock Values 1.Key Profitability Ratios in Bank
4、ing 2.Interpreting Profitability Ratios 3.Useful Profitability Formulas for Banks and Other Financial Service Companies 4.Breaking Down Equity Returns for Closer Analysis 5.Break-Down Analysis of the Return on Assets 6.What a Breakdown of Profitability Measures Can Tell Us D.Measuring Risk in Bankin
5、g and Financial Services 1.Credit Risk 2.Liquidity Risk 3.Market Risk 4.Interest-Rate Risk 5.Earnings Risk 6.Capital Risk 7.Other Forms of Risk in Banking and Financial Services(Inflation Risk,Currency or Exchange-Rate Risk,Political Risk,and Crime Risk)E.Other Goals in Banking and Financial Service
6、s Management III.Performance Indicators among Bankings Key Competitors IV.The Impact of Size on Performance 48 V.Size,Location and Regulatory Bias in Analyzing The Performance of Banks and Competing Financial Institutions VI.Using Financial Ratios and Other Analytical Tools to Track Bank Performance
7、-The UBPR.VII.Summary of the Chapter Appendix to the Chapter-Improving the Performance of Banks and Other Financial Firms Through Knowledge:Sources of Information on the Banking and Financial-Services Industry Concept Checks 5-1.Why should banks and other corporate financial firms be concerned about
8、 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 public to fund their operations.If profits are inadequate or if risk is excessive,they will have greater difficulty in obtaining capital and their fu
9、nding costs will grow,eroding profitability.Bank stockholders,depositors,and bank examiners representing 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 h
10、olding 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 these dimensions of performance for a bank or other financial institution?The individuals or groups likely to be
11、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 the stock price of a bank or other financial corporation?A
12、 banks stock price is affected by all those factors affecting its profitability and risk exposure,particularly its rate of return on equity capital 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
13、,by lowering the banks perceived risk exposure,or by a combination of increases in expected earnings and reduced risk.5-4.Suppose 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
14、 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 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)=$80.49 5-5.What is return o
15、n equity capital and what aspect of bank performance is it supposed to measure?Can you see how this performance measure might be useful to the managers of nonbank financial firms?Return on equity capital is the ratio of Net Income After Taxes/Total Equity Capital.It represents the rate of return ear
16、ned on the funds invested in the bank by its stockholders.Most nonbank financial firms have stockholders,too who are interested in the return on the funds that they invested.5-6 Suppose a bank reports that its net after-tax income for the current year is$51 million,its assets total$1,144 million,and
17、 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?The banks return on equity capital should be:ROE=Net After Tax Income =$51 million=.098 or 9.8 percent Equity Capital$1,444
18、 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.5-7 What is the return on assets(ROA),and why is it important in banking?Might the ROA measure be important to bankings key competitors?Return o
19、n assets is the ratio of Net Income After Taxes/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 resources(assets)committed to the institution.5-8.A bank estimates that its total revenues from all sour
20、ces 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 banks return on assets?Is this ROA high or low?How could you find out?The banks return on assets would
21、 be:ROA=Net After Tax Income=$155 mill.-$107 mill.=0.0096 or 0.96 percent Total Assets$4,960 mill.+$52 mill.The size of this banks ROA should be compared with the ROAs of other banks similar in size and location to determine if this banks ROA is high or low relative to the average for comparable ban
22、ks.50 5-9.Why do bankers and the managers of competing financial firms often pay close attention today to the net interest margin and noninterest margin?To the earnings spread?The net interest margin(NIM)indicates how successful the bank has been in borrowing funds from the cheapest sources and in m
23、aintaining 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 the average cost of funds must be falling or both.A declining NIM is undesirable because the banks interest spread is bei
24、ng squeezed,usually because of rising interest costs on deposits and other borrowings.In 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).For mos
25、t banks the noninterest margin is negative.Management will usually attempt to expand fee income,while controlling closely the growth of noninterest expenses in order to make a negative noninterest margin as least negative as possible.The earnings base indicates the proportion of the banks earning as
26、sets(loans,leases,and investments)relative to its total assets.As competition increases,greater pressure is placed on the banks management to maintain the quality and quantity of these earning assets.Additionally,the banks managers typically will shift some of their emphasis to increasing noninteres
27、t income generated by fees.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,the spread between the average yields on assets and the average cost
28、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.5-10.Suppose a banker tells you that his bank in the year just completed had total interest expenses on all borrowings of$12 million and noninte
29、rest 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 represented 85 percent of total assets,while total interest-bearing liabilities am
30、ounted to 75 percent of the banks 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 margins must be:Net Interest =$16 mill.-$12 mill.Noninterest=$2 mill.-$5 m
31、ill.Margin$480 mill.Margin$480 mill.=.00833 =-.00625 The banks earnings spread and earnings base are:Earnings=$16 mill.-$12 mill.Spread$480 mill*0.85$480 mill.*0.75 51 =.0392 -.0333 Earnings Base=$480 mill.-$480 mill.*0.15=0.85 or 85 percent$480 mill.5-11.What are the principal components of ROE and
32、 what do each of these components measure?The principal components of ROE are:a.The net profit margin or net after-tax income to operating revenues which reflects the effectiveness of a banks expense control program;b.The degree of asset utilization or ratio of operating revenues to total assets whi
33、ch 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.5-12.Suppose a bank has an ROA of 0.80 percent and an equity multipli
34、er 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 equity multiplier can be determined from:ROE=9.60%=0.60 percent*E
35、quity Multiplier Equity Multiplier=9.60 percent=16x.0.60 percent 5-13.Suppose a bank reports net income after taxes of$12,before-tax net income of$15,operating revenues of$100,assets of$600,and$50 in equity capital.What is the banks ROE?Tax-management efficiency indicator?Expense control efficiency
36、indicator?Asset management efficiency indicator?Funds management efficiency indicator?The banks ROE must be:ROE=50$12$=0.24 or 24 percent 52 Its tax-management,expense control,asset management,and funds management efficiency indicators are:Tax Management=$12 Expense Control=$15 Efficiency indicator$
37、15 Efficiency Indicator$100 =.8 or 80 percent =.15 or 15 percent Asset Management=$100 Funds Management=$600 Efficiency Indicator$600 Efficiency Indicator$50 =0.1666 or 16.67 percent =12 x 5-14.What are the most important components of ROA and what aspects of a financial institutions performance do
38、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 Total Assets which measures managements ability to contr
39、ol 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.Net Income Before Taxes divided by Total Assets,which me
40、asures operating efficiency and expense control;and e.Applicable Taxes divided by Total Assets,which is an index of tax management effectiveness.5-15.If a bank has a net interest margin of 2.50%,a noninterest margin of-1.85%,and a ratio of provision for loan losses,taxes,security gains,and extraordi
41、nary items of-0.47%,what is its ROA?The banks ROA must be:ROA=2.50 percent-1.85 percent-0.47 percent=0.18 percent 5-16.To what different kinds of risk are banks and their financial-service competitors subjected today?a.Earnings Risk-the probability that a banks earnings(net income)will fall,subjecti
42、ng its stockholders to actual losses or to lower rates of return.53 b.Credit Risk-the probability that loans and securities the bank holds will not pay out as promised.c.Solvency Risk-the possibility or probability the bank will fail.d.Liquidity Risk-the probability the bank will not have sufficient
43、 cash on hand in the volume needed precisely when cash demands arise.e.Market Risk-the probability that the value of assets held by the bank will decline due to falling market prices.f.Interest-Rate Risk-the possibility or probability interest rates will change,subjecting the bank to losses.5-17.Wha
44、t items on a banks balance sheet and income statement can be used to measure its risk exposure?To what other financial institutions do these risk measures apply?There are several alternative measures of risk in banking and financial services.Capital risk is often measured by bank capital ratios,such
45、 as the ratio of total capital to total assets or total capital 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
46、.Interest-rate risk may be indicated by such ratios as interest-sensitive liabilities to interest-sensitive assets or the ratio of money-market borrowings to money-market assets.5-18.A bank reports that the total amount of its net loans and leases outstanding is$936 million,its assets total$1,342 mi
47、llion,its equity capital amounts to$110 million,and it holds$1,150 million in deposits,all expressed in book value.The estimated market values of the banks total assets and equity capital are$1,443 million and$130 million,respectively.The banks stock is currently valued at$60 per share with annual p
48、er-share earnings of$2.50.Uninsured deposits amount to$243 million and money market borrowings total$1 32 million,while nonperforming loans currently amount to$43 million and the bank just charged off$21 million in loans.Calculate as many of the banks risk measures as you can from the foregoing data
49、.Net Loans and Leases=$936 mill.Uninsured Deposits$243 mill.Total Assets$1,324 mill.Total Deposits$1,1150 mill.0.7069 or 70.69 percent 0.2113 or 21.13 percent Equity Capital=$130 mill.Stock Price$60 Total Assets$1,443 mill.Earnings Per Share$2.50 54=0.0901 or 9.01 percent =24 X Nonperforming Assets=
50、$43 mill.=0.0459 or 4.59 percent Net Loans and Leases$1,443 mill.Charge-offs of loans=$21 Purchased Funds=$243 mill.+$132 mill.Total Loans and Leases$936 Total Liabilities$1,324 mill.-$110 mill.=.0224 or 2.24 percent .3089 or 30.89 percent Book Value of Assets=$1324=0.9175 or 91.75 percent Market Va