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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 Appendix: Using Financial Ratios
3、 and Other Analytical Tools to Track Financial Firm Performance-The UBPR and BHCPRChapter OutlineI. Introduction:II Evaluating PerformanceA. Determining Long-Range ObjectivesB. Maximizing the Value of the Firm: A Key Objective for Nearly All Financial-Service InstitutionsC. Profitability Ratios: A S
4、urrogate for Stock Values1. Key Profitability Ratios2. Interpreting Profitability RatiosD. Useful Profitability Formulas for Banks and Other Financial-Service CompaniesE. Return on Equity and Its Principal ComponentsF. The Return on Assets and Its Principal Components G. What a Breakdown of Profitab
5、ility Measures Can Tell UsH. Measuring Risk in Banking and Financial Services1. Credit Risk2. Liquidity Risk3. Market Risk4. Price Risk5. Interest Rate Risk6. Foreign Exchange and Sovereign Risk7. Off-Balance-Sheet Risk8. Operational (Transactional) Risk9. Legal and Compliance Risks10 Reputation Ris
6、k11. Strategic Risk12. Capital RiskI. Other Goals in Banking and Financial-Services ManagementIII. Performance Indicators among Bankings Key CompetitorsIV.The Impact of Size on PerformanceA. Size, Location and Regulatory Bias in Analyzing the Performance of Banks and Competing Financial Institutions
7、V. Summary of the ChapterAppendix to the Chapter - Using Financial Ratios and Other Analytical Tools to Track Financial-Firm Performance-The UBPR and BHCPRConcept Checks6-1.Why should banks and other corporate financial firms be concerned about their level of profitability and exposure to risk?Banks
8、 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 funding costs will grow, eroding profitability. Bank st
9、ockholders, 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 holding bank stock, while depositors (especially
10、large corporate depositors) and examiners typically focus on bank risk exposure.6-2.What individuals or groups are likely to be interested in these dimensions of performance for a financial institution?The individuals or groups likely to be interested in the dimensions i.e., Bank profitability and R
11、isk are 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.6-3.What factors influence the stock price of a financial-services corporation?A banks stock price is affected by all thos
12、e factors affecting its profitability and risk exposure, particularly its rate of return on equity capital and risk to shareholder earnings. Research evidence over the years has found that the stock prices of financial institutions is sensitive to changes in market interest rates, currency exchange
13、rates, and the strength or weakness of the economy. 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.6-4.Suppo
14、se 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 based on the banks perceived level of risk is 10 percent. Can you estimate the cur
15、rent value of the banks stock?In this constant dividend growth rate problem the current value of the banks stock would be:Po = D1 / (r 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
16、might be useful to 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, who too are interested in the return on the f
17、unds that they invested.6-6 Suppose a bank reports that its net income for the current year is $51 million, its assets total $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 a
18、nswer this last question?The banks return on equity capital should be:ROE =Net Income =$51 million= 0.234 or 23.39 percentTotal equity Capital$1,144 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 ave
19、rage.6-7What is the return on 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 ne
20、t income from all of the resources (assets) committed to the institution. This would be important to banks and their major competitors.6-8.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
21、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 be:ROA =Net Income=$155 mill. - $107 mill.= 0.0096 or 0.96 percentTotal Assets$4,960 mill. + $52 mill.The size of
22、 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.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 inte
23、rest 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 the a
24、verage 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 increased competition today.In contrast, the noninterest margin reflects the banks spread be
25、tween 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 growth of noninte
26、rest 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, the spread betwe
27、en 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 had total inter
28、est 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 totaled $2 million. Suppose further that assets amounted to $480 million, of which earning assets represented 85 percent of that
29、 total 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 margins must be:Net Interest =$16
30、 mill. - $12 mill.Noninterest=$2 mill. - $5 mill.Margin$480 mill.Margin$480 mill.= 0.00833= -0.00625The banks earnings spread and earnings base are:Earnings=$16 mill.-$12 mill.Spread$480 mill * 0.85$480 mill. * 0.75= 0.0392= 0.0333=0.0059Earnings Base=$480 mill. ($480 mill. * 0.15)=0.85 or 85 percen
31、t$480 mill.6-11. What are the principal components of ROE, and what does each of these components measure?The principal components of ROE are:a. The net profit margin or net after-tax income to Total operating revenues which reflects the effectiveness of a banks expense control program and service p
32、ricing policies;b. The degree of asset utilization or ratio of Total operating revenues to Total assets which measures the effectiveness of managing the banks portfolio management policies, especially the mix and yield on assets; and,c. The equity multiplier or ratio of Total assets to Total equity
33、capital which measures a banks use of leverage in funding its operations: sources chosen to fund the financial institution (debt or equity).6-12.Suppose a bank 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
34、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 * Equity Multiplier Equity Multiplier = 9.60 percent = 16X. 0.60 percent6-13.Su
35、ppose a bank reports net income of $12, pre-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 indicator? Asset management efficiency indicator? Funds management efficien
36、cy indicator?The banks ROE must be:ROE = = 0.24 or 24 percent Its tax-management, expense control, asset management, and funds management efficiency indicators are:Tax Management=$12Expense Control=$15Efficiency indicator$15Efficiency Indicator$100= 0.8 or 80 percent= 0.15 or 15 percentAsset Managem
37、ent=$100Funds Management=$600Efficiency Indicator$600Efficiency Indicator$50= 0.1667 or 16.67 percent= 12 xAlternative Calculation for ROE = 0.8 0.15 0.1667 12 = 0.24 or 24%6-14.What are the most important components of ROA, and what aspects of a financial institutions performance do they reflect?Th
38、e 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 control loan loss
39、es 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, other noninterest costs and generate the income;d. Net Income Before Taxes divided by Total Assets, which measures oper
40、ating efficiency and expense control; ande. Applicable Taxes divided by Total Assets, which is an index of tax management effectiveness.6-15.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 extraordinar
41、y items of -0.47%, what is itsROA?The banks ROA must be:ROA = Net interest margin + Noninterest margin Ratio of provision for loan losses, taxes, security gains, and extraordinary itemsROA = 2.5 percent + (-1.85 percent) (-.47 percent) = 1.12 percent6-16.To what different kinds of risk are banks and
42、 their financial-service competitors subjected today?a. Credit Risk - the probability that the loans and securities the bank holds will not pay out as promised.b. Liquidity Risk - the probability that the bank will not have sufficient cash on hand in the volume needed precisely when cash demands ari
43、se.c. Market Risk - the probability that the market value of assets held by the bank will decline due to falling market prices.d. Price Risk the probability or possibility that the value of bond portfolios and stockholders equity may decline due to market prices movement against the financial firm.e
44、. Interest-Rate Risk - the possibility or probability that the interest rates will change, subjecting the bank to lower profits or a lower value for the firms capital.f. Foreign Exchange and Sovereign Risk the uncertainty that due to fluctuation in currency prices, assets denominated in foreign curr
45、encies may fall, forcing the written down of these assets on its Balance Sheet.g. Off-Balance-Sheet Risk the probability that the volume of off-balance-sheet commitments far exceeds the volume of conventional assets.h. Operational Risk the uncertainly regarding a financial firms earnings due to fail
46、ures in computer systems, employee misconduct, floods, lightening strikes and other similar events.i. 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 regulations.j. Reputation Risk the uncertai
47、nty due to public opinion or the variability in earnings due to positive or negative publicity about the financial firm.k. Strategic Risk the uncertainty in earnings due to adverse business decisions, lack of responsiveness to industry changes and other poor decisions by management.k. Capital Risk the risk that the value of the assets 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.6-17.What items on a banks bal