slike bài giảng quản trị ngân hàng chương 10measuring and evaluating the performance of banks and their principal competitors

Value of a bank’s stock rises when: Expected dividends increase  Risk of the bank falls  Market interest rates decrease  Combination of expected dividend increase and risk decline 6

William Chittenden edited and updated the PowerPoint slides for this edition.

MEASURING &

EVALUATING THE PERFORMANCE OF BANKS

Chapter 10

Key topics

1. Stock values and profitability ratios

2. Measuring credit, liquidity, and other risks

3. Measuring operating efficiency

4. Performance of competing financial firms

5. Size and location effects

6. The UBPR and comparing performance

6-2

Banks’ key objectives

Value of the bank’s stock

6-4

Value of a bank’s stock rises when:

 Expected dividends increase

 Risk of the bank falls

 Market interest rates decrease

 Combination of expected dividend increase and risk

decline

6-5

Value of bank’s stock

if earnings growth is constant

g -

r

D

6-6

Key profitability ratios in banking

Assets Total

Income Interest

Net Assets

Total

expense) Interest

-income (Interest

Margin Interest

Assets Total

Income

t Noninteres

Net Assets

Total

expenses

t Noninteres -

PLLL -

revenue

t Noninteres

Margin

t Noninteres

Net Income Return on Equity Capital (ROE) =

Total Equity Capital

Net IncomeReturn on Assets (ROA) =

Total Assets

6-7

Key profitability ratios in banking (cont.)

g Outstandin Shares

Equity Common

Taxes After

Income

Net (EPS)

Share Per

Total Interest Income Total Interest Expense Earnings Spread = Total Earning Assets Total Interest Bearing

Liability

6-8

Assets Total

Expenses Operating

Total

Revenues Operating

-Total Margin

Operating Bank

Assets Total

Assets

Earning Base

Breaking down ROE

Return on equity (ROE = NI / TE)

… the basic measure of stockholders’ returns

 ROE is composed of two parts:

 Return on Assets (ROA = NI / TA),

 represents the returns to the assets the bank has invested in

 Equity Multiplier (EM = TA / TE),

 the degree of financial leverage employed by the bank

Return on assets (ROA = NI / TA)

…can be decomposed into two parts:

• Asset Utilization (AU) → income generation

• Expense Ratio (ER) → expense control

= (TR / TA) - (TE / TA)

Where:

TR = total revenue or total operating income

= Int inc + Non-int inc + SG and

TE = total expenses

= Int exp + Non-int exp + PLL + Taxes

ROA is driven by the bank’s ability to:

…generate income (AU) and control expenses (ER)

 Income generation (AU) can be found on the UBPR

(page 1) as:

TA

losses) (

gains

Sec TA

Exp

int

Non TA

Exp

Int

Note, ER* does not include taxes.

ROE depends on:

 Equity multiplier=Total assets/Total equity capital

 Leverage or financing policies: the choice of sources of funds (debt

or equity)

 Net profit margin=Net income/Total operating revenue

 Effectiveness of expense management (cost control)

 Asset utilization=Total operating revenue/Total assets

 Portfolio management policies (the mix and yield on assets)

6-13

Overhead

Prov for LL Taxes

Fees and Serv Charge Trust

Other

Rate Composition (mix) Volume

Bank Performance Model

Bank Performance Model

Expense ratio (ER = Exp / TA)

… the ability to control expenses

 Interest expense / TA

 Cost per liability (avg rate paid)

 Int exp liab (j) / $ amt liab (j)

 Other operating expense / TA

 Provisions for loan losses / TA

 Taxes / TA

Asset utilization (AU = TR / TA):

… the ability to generate income.

 Interest Income / TA

 Asset yields (avg rate earned)

 Interest income asset (i) / $ amount of asset (i)

 Composition of assets (mix)

 $ amount asset (i) / TA

 Volume of Earning Assets

 Earning assets / TA

 Noninterest income / TA

 Fees and service charges

 Securities gains (losses)

 Other income

Determinants

of ROE in a

financial firm

6-17

Components of ROE for all insured U.S

Banks (1992-2007)

6-18

A variation on ROE

Net Income Pre-Tax Net Operating Income ROE =

Pre-Tax Net Operating Income × Total Operating Revenue ×

Total Operating Revenue Total Assets

Total Assets × Total Equity Capital

ROE = Tax Management Efficiency

Expense Control Efficiency

Asset Management Efficiency

Funds Management Efficiency

×

×

×

6-19

Breakdown of ROA

6-20

Financial ratios

…PNC and Community National Bank

UBPR for PNC

Interest expense

…composition, rate and volume effects for PNC and Community National Bank

Interest income

…composition, rate and volume effects for PNC and Community National Bank

Quick quiz

1 What individuals or groups are likely to be interested in the

banks’ level of profitability and exposure to risk?

2 What are the principal components of ROE, and what does

each of the these components measure?

3 Suppose a bank has an ROA of 0.80% and an equity

multiplier of 12x What is its ROE? Suppose this bank’s

ROA falls to 0.60% What size equity multiplier must it

have to hold its ROE unchanged?

4 What are the most important components of ROA and what

aspects of a financial institution’s performance do they

reflect?

6-24

Bank risk

… Popular measures of overall risk

1. Standard deviation (σ) or variance (σ2) of stock

price

2. Standard deviation or variance of net income

3. Standard deviation or variance of ROE & ROA

The higher σ and σ2, the greater the overall risk

Credit risk

The probability that some of the financial firm’s assets will decline in value and perhaps become worthless

resulting from nonpayment or delayed payment on

loans and securities

6-27

Credit risk measures

1. Nonperforming loans/Total loans

2. Net charge-offs/Total loan

3. Provision for loan losses/Total loan

4. Provision for loan losses/Equity capital

5. Allowance for loan losses/Total loan

6. Allowance for loan losses/Equity capital

7. Nonperforming loans/Equity capital

6-28

Credit risk: more ratios to consider

 Three Questions need to be addressed:

1. What has been the loss experience?

2. What amount of losses do we expect?

3. How prepared is the bank?

Credit ratios to consider

 What has been the loss experience?

1 Net loss to average total Loan & Lease (LN&LS)

2 Gross losses to average total LN&LS

3 Recoveries to avg total LN&LS

4 Recoveries to prior period losses

5 Net losses by type of LN&LS

 What amount of losses do we expect?

1 Non-current LN&LS to total loans

2 Total Past/Due LN&LS - including nonaccrual

3 Non-current & restruc LN&LS / Gross LN&LS

4 Current - Non-current & restruc/ Gr LN&LS

5 Past due loans by loan type

Credit ratios to consider (cont.)

 How prepared are we?

1. Provision for loan loss to: average assets and

average total LN&LS

2. LN&LS Allowance to: net losses and total

LN&LS

3. Earnings coverage of net loss

Credit risk ratios :

PNC and Community National

Liquidity risk measures

1. Purchased funds/Total assets

2. Net loans/Total assets

3. Cash and due from banks/Total assets

4. Cash and government securities/Total sssets

6-34

Liquidity risk ratios :

PNC and Community National

Market risk: comprises price risk and

interest rate risk

Probability of the market value of the financial firm’s investment portfolio declining in value due to a

change in interest rates

6-36

Market risk measures

1. Book-value of assets/ Market value of assets

2. Book-value of equity/ Market value of equity

3. Book-value of bonds/Market value of bonds

4. Market value of preferred stock and common stock

6-37

Interest rate risk

The danger that shifting interest rates may adversely affect a bank’s net income, the value of its assets or

equity

6-38

Interest rate risk measures

1. Interest sensitive assets/Interest sensitive liabilities

2. Uninsured deposits/Total deposits

6-39

Foreign exchange risk

… the risk to a financial institution’s condition resulting from adverse movements in foreign exchange rates

 Foreign exchange risk arises from changes in foreign exchange rates that affect the values of assets,

liabilities, and off-balance sheet activities denominated

in currencies different from the bank’s domestic

(home) currency.

 This risk is also often found in off-balance sheet loan commitments and guarantees denominated in foreign currencies; foreign currency translation risk

Off-balance-sheet risk

The volatility in income and market value of bank

equity that may arise from unanticipated losses due to OBS activities (activities that do not have a balance

sheet reporting impact until a transaction is affected)

6-41

Operational risk

Uncertainty regarding a financial firm’s earnings due

to failures in computer systems, errors, misconduct

by employees, floods, lightening strikes and similar

events or risk of loss due to unexpected operating

expenses

6-42

Legal and compliance risk

Risk of earnings resulting from actions taken by the

legal system This can include unenforceable

contracts, lawsuits or adverse judgments Compliance risk includes violations of rules and regulations

6-43

Strategic risk

The variations in earnings due to adverse business

decisions, improper implementation of decisions, or lack of responsiveness to industry changes

6-45

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

6-46

Capital risk measures

1. Stock price/Earnings per share

2. Equity capital/Total assets

3. Purchased funds/Total liabilities

4. Equity capital/Risk assets

6-47

Other goals in banking

Total Operating Expenses Operating Efficiency Ratio =

Total Operating Revenues

Net Operating Income Employee Productivity Ratio =

Number of Full Time-Equivalent Employees

6-48

Average performance characteristics of

banks by business concentration and size

 ROE and ROA (up to $10 billion in assets) increases

with bank size

 Employees per dollar of assets decreases with bank

Bank performance measure by size

Bank risk measures by size

Average performance characteristics of

banks by business concentration and size

 Focus on consumer, small business, mortgage, and

agriculture loans and obtain deposits form individuals and small businesses

Profitability measures of banks by business concentration

Risk measures of banks by business concentration

Performance indicators related to the size

of a firm, 2007

6-55

Appendix: UBPR

The Uniform Bank Performance Report (UBPR)

provided by U.S Federal regulators so that analysts

can compare the performance of one bank against

another

Web link for UBPR and BHCPR: www.ffiec.gov

6-56

Questions & Problems

concerned about their level of profitability and exposure to risk?

attention today to the net interest margin and noninterest

margin? To the earnings spread?

be used to measure its risk exposure? To what other financial institutions do these risk measures seem to apply?

William Chittenden edited and updated the PowerPoint slides for this edition.

MEASURING &

EVALUATING THE PERFORMANCE OF BANKS

Chapter 10