1. Bank Performance
BFB2033
Week 6
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2. Key Topics
•
•
•
•
Stock Values and Profitability Ratios
Measuring Credit, Liquidity, and Other Risks
Measuring Operating Efficiency
Size and Location Effects
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3. Why should banks be concerned
about profitability and risk?
• Profitability and risk are the most important
dimensions of performance. Banks are private
businesses that must attract capital from the
public to fund their operations.
• Bank stockholders, depositors, and bank
examiners representing the regulatory
community are all interested in the quality of
bank performance.
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4. Stock Values and profitability ratio
• Performance refers to how adequately a firm meets the needs
of its stockholders, employees, depositors, creditors and
borrowing customers within the satisfaction of government
regulators on operating policies, soundness of loans and
investments and protecting public interest.
• Performance must be directed towards specific objectives and
normally tied to value of stock.
• Management must pursue objective of maximizing the
financial firm’s stock.
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5. Who is likely to be interested in
these dimensions of
performance?
•
The individuals or groups likely to be interested in bank
profitability and risk are:
•
•
•
•
Other banks lending to a particular bank,
large depositors,
holders of long-term debt capital issued by banks,
bank stockholders, and the regulatory community.
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6. Name LD change % chan Vol Buy V Buy Sell Sell V High
Ambank 7.5 0.01 0.13 1,725 697 7.49 7.5 1,071 7.5
BIMB
4.94 293 130 4.95 4.94 6 4.94
CIMB
7.64 0.09 1.19 33,764 31 7.63 7.54 744 7.64
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7. Importance of value of stock
• If stock fails to rise in value commensurate with stockholder
expectations current investors may seek to unload their
shares and financial institutions may have difficulty in raising
new capital to support future growth.
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8. 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
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9. Value of the Bank’s Stock
∞
E(Dt)
P0 = ∑
t
t =0 (1 + r)
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10. Example
• Suppose that stockbrokers have projected that Yorktown
Savings will pay a dividend of $3 per share on its common
stock at the end of the year; a dividend of $4.50 per share is
expected for the next year, and $ 5.50 per share in the
following two year. The risk-adjusted cost of capital for banks
in Yorktown’s risk class is 15 percent. If an investor holding
Yorktown’s stock plans to hold that stock for only four years
and hopes to sell it at a price of $60 per share, what should
the value of the bank’s stock be in today’s market?
P0 = $47.08 per share.
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11. Profitability ratios : A surrogate
for stock values
• Behavior of stock price is best indicator of financial firm’s performance because
it reflects market evaluation of firm. However not applicable to smaller
institutions.
• Therefore to assess these banks we need to look at profitability ratios.
• Return on Assets = ( Net Income/ Total Assets )
Indicates managerial efficiency. It indicates how capable management has
been in converting assets into net earnings.
• Return on Equity = ( Net Income/Total Equity capital)
Return on Equity is determined by dividing net income (minus preferred
dividends) by average common stockholders equity to get the return on
equity.
Net benefit that stockholders have received from investing their capital in the
financial firm.
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12. Value of Bank’s Stock if Earnings
Growth is Constant
D1
P0 =
r-g
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13. Example
• 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
minimum required return-to-equity capital based on the
bank's perceived level of risk is 10 percent. Can you estimate
the current value of the bank's stock?
• In this constant dividend growth rate problem the current
value of the bank's stock would be:
• Po = D1 / (r – g) = $4 / (0.10 – 0.05) = $80.
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14. Key Profitability Ratios in Banking
Net Income
Return on Equity Capital (ROE) =
Total Equity Capital
Net Income
Return on Assets (ROA) =
Total Assets
Net Interest Income
Net Interest Margin =
Total Assets
Net Noninterest Income
Net Noninterest Margin =
Total Assets
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15. Problem
• The following information is for Blue Sky National
Bank:
• Interest income
$2,200
• Interest expense
$1,400
• Total assets
$45,000
• Securities losses or gains
$21
• Earning assets
$40,000
• Total liabilities
$38,000
• Taxes paid
$16
• Shares of Common Stock outstanding $5,000
• Noninterest income
$800
• Noninterest expense
$900
• Provision for loan losses
$100
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16. Problem
Please calculate:
• ROE
-------------• ROA
• Net interest margin
-------------• Earnings per share
-------------• Net noninterest margin
-------------• Net operating margin
--------------
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17. Solution
• ROE =
$605
.
$45,000 - $38,000
= 0.0864or 8.64 percent
• ROA =
$605
$45,000
= 0. 0134 or 1.34 percent
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18. Solution
• Net Interest = $2,200 - $1400 =
$800 = 0.02 or 2 %
Margin
$40,000
$40,000
• Net Noninterest = $800 - $900 = -$100 = -0.0025 or -0.25%
Margin
$40,000 $40,000
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19. Key Profitability Ratios in
Banking (cont.)
Total Operating Revenues Total Operating Expenses
Net Bank Operating Margin =
Total Assets
Earnings Per Share (EPS) =
Net Income After Taxes
Common Equity Shares Outstanding
Total Interest Income
Earnings Spread = Total Earning Assets
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__ Total Interest Expense
Total Interest Bearing Liability
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20. Solution
• Earnings
Per Share
=
$605
5,000
= $.121 per share
• Net Operating = ($2,200 + $800) – ($1,400 + $900 + $100)
Margin
$45,000
=
$600
$45,000
= 0.0133 or 1.33 percent
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21. ROE
• 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 answer this last question?
• The bank's return on equity capital should be:
• ROE = Net Income =
$51 million
Total equity Capital $1,144 mill.-$926 mill.
= 0.234 or 23.39
• I n 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.
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22. ROA – indicates efficiency in
generating income from its assets
• 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
equity capital amounts to $52 million. What is the bank's
return on assets? Is this ROA high or low? How could you find
out?
• The bank's return on assets would be:
ROA = Net Income = $155 mill. - $107 mil = 0.0096 or 0.96 %
Total Assets $4,960 mill. + $52 mill.
• The size of this bank's ROA should be compared with the
ROA's of other banks similar in size and location to determine
if this bank's ROA is high or low.
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23. Net interest and non-interest
margins
• The net 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
• 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).
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24. Net interest and non – interest
margins
• Suppose a banker tells you that his bank in the
year just completed 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. See if you can determine this
bank's net interest and noninterest margins.
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25. Solution
• The bank's net interest and noninterest margins must be:
• Net Interest
Margin
= $16 mill. - $12 mill. = 0.00833
480 mill.
• Noninterest = $2 mill. - $5 mill. = -0.00625
Margin
$480 mill.
• The bank's earnings spread and earnings base are:
Earnings
=
$16 mill.
- $12 mill.
Spread
$480 mill * 0.85
$480 mill. * 0.75
= 0.0392
= 0.0333
= 0.005
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26. Solution
Earnings Base = $480 mill. – ($480 mill. * 0.15)
$480 mill.
= 0.85 or 85 percent
•
•
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27. Breaking Down ROE
R O E = N e t I n c o m e / T o t a l E q u it y C a p it a l
ROA =
N e t In c o m e / T o t a l A s s e ts
x
E q u it y M u lt ip lie r =
T o t a l A s s e t s / E q u it y C a p it a l
N e t P r o f it M a r g in =
A s s e t U tiliz a t io n =
x
N e t I n c o m e /T o t a l O p e r a tin g R e v e n u e T o t a l O p e r a t in g R e v e n u e / T o t a l A s s e ts
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28. ROE Depends On:
• Equity Multiplier = Assets/Equity
• Leverage or Financing Policies
• Net Profit Margin= Net Income/Total Operating revenue
• Effectiveness of Expense Management
• Asset Utilization = Total operating revenue/Total Assets
• Portfolio Management Policies
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29. Bank Risks
• Credit Risk
• Liquidity Risk
• Market Risk
• Interest Rate Risk
• Operational Risk
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• Legal and
Compliance Risk
• Reputation Risk
• Strategic Risk
• Capital Risk
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30. Credit Risk
The Probability that Some of the
Financial Firm’s Assets Will Decline in
Value and Perhaps Become Worthless
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31. Credit Risk
• Probability that some of the financial institution’s assets
especially its loans will decline in value is known as credit risk.
• 4 widely used indicators are:
1.Non performing assets/ total loans and leases.
2.Net charge offs (write offs) of loans/ total loans and
leases
3.Annual provision of loan losses/ total loans and leases
4.Allowance for loan losses/ Total loans and leases
5.Non performing assets/ equity capital
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32. Liquidity Risk
Probability the Financial Firm Will Not
Have Sufficient Cash and Borrowing
Capacity to Meet Deposit Withdrawals
and Other Cash Needs
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33. 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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34. Market Risk
Probability of the Market Value of the
Financial Firm’s Investment Portfolio
Declining in Value Due to a Change in
Interest Rates
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35. 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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36. 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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37. Interest Rate Risk Measures
• Interest Sensitive Assets/Interest
Sensitive Liabilities
• Uninsured Deposits/Total Deposits
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38. 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
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39. 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
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40. Reputation Risk
This is Risk Due to Negative Publicity that can Dissuade Customers
from Using the Services of the Financial Firm. It is the Risk
Associated with Public Opinion.
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41. 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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42. Capital Risk Measures
• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets
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43. 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
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44. Measuring operating
efficiency
• Many firms recognize the need for greater efficiency in their
operations. Means reducing op expenses and increasing
productivity of employees through use of automated
equipment and improved employee training.
• Operating Efficiency Ratio
A common means of measuring the operating
efficiency for banks is a ratio that divides the total
operating expense of the bank/total operating
revenues.
• Employee productivity ratio
Net operating income/ number of full time employees
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45. Size and location effects
• Size bias is evident in banking industry. Measured by assets,
deposits or equity capital. Largest bank usually report highest
non interest margins. Most profitable banks in terms of ROA
were banks with more than 10 billion in assets. Local- CIMB,
Maybank.
• Location effects- Performance is influenced by whether it
operates in a major financial centre, smaller city or rural area.
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46. Calculate as many risk measures
as you can from the following
dataloans and leases book value = $936
• Net
•
•
•
•
•
•
•
•
•
•
Total assets = $1324 mill
Equity capital book value =$ 110 mill
Deposits book value = $1150 mill
Market value assets = $1443 mill
Market value of equity cap = $130 mill
Current stock price = $60 with annual per share earnings
of $2.50
Uninsured deposits = $243 mill
Money market borrowings = $132 mill
Non performing loans = $43 mill
Loans charged off = $21 mill
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47. solution
•
•
•
•
•
•
•
•
Net loans and leases/total assets = 936/1324
Equity capital/total assets = 130/1443
Uninsured deposits/total deposits = 243/1150
Stock price/EPS = 60/250
Non performing assets/net loans and leases 43/936
Charge offs of loans/total loans and leases= 21/936
Purchased funds /total liabilities = 243 +132/1324-110
Book value of assets/market value of assets = 1324/1443
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