Ch04

Traditional bank performance analysis carries three basic flaws ,[object Object],[object Object],[object Object]

Wide diversity in strategies pursued by different institutions ,[object Object],[object Object],[object Object],[object Object]

Bank’s total assets no longer serve as a meaningful yardstick when banks engage in off-balance sheet activities ,[object Object],[object Object]

The analysis provides no direct information concerning how or which of the bank’s activities contribute to the creation of shareholder value ,[object Object]

Although ROA might be a biased indicator of performance, return on equity (ROE) doesn’t suffer from the same weaknesses. ,[object Object],[object Object]

The appropriate peer group …as long as banks have a similar strategic focus and offer similar products and services, asset size and UBPR ratios can provide meaningful comparisons. ,[object Object],[object Object],[object Object],[object Object]

A common starting point is to determine whether the bank’s strategy is more loan-driven or deposit-driven. ,[object Object],[object Object]

A loan driven bank finds that: ,[object Object],[object Object],[object Object],[object Object],[object Object]

A deposit driven bank typically finds that: ,[object Object],[object Object],[object Object],[object Object]

Evaluating performance using GAAP-based data and UBPR ratios …a bank should compare its ratios with those from a select sample of peer institutions that are similarly loan-driven or deposit-driven. ,[object Object],[object Object],[object Object]

One way to construct ratios that avoid the problems of off-balance sheet activities is to calculate ratios tied to a bank’s total operating revenue (net interest income plus noninterest income) - - (David Cates (1996)) ,[object Object],[object Object]

The efficiency ratio …measured as noninterest expense divided by total operating revenue, is a popular measure used by stock analysis based on operating revenue rather than assets. ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Bank stock analysts follow a standard procedure when evaluating firm performance ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

It is extremely rare, however, to see an outright sell recommendation because analysts want to remain in the good graces of the banks that they follow ,[object Object],[object Object],[object Object]

Investors in bank stocks are primarily concerned with whether the bank’s management is creating value for stockholders. ,[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object],Key stock market-based performance measures include

Example: buy 100 shares of PNC Financial at the beginning of 2001 for $73.06. The bank paid $1.92 per share in dividends that generated reinvestment income of $.09. At the end of 2001, the price of stock was $56.20. ,[object Object],[object Object]

Balanced scorecard …performance measures that look beyond just financial measures ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],Such nonfinancial indicators provide information regarding whether a bank is truly customer-focused and whether its systems are appropriate

Operationalize the balanced scorecard …divide the bank into a Customer Bank and a House Bank ,[object Object],[object Object]

Two banks in one house ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Line of business profitability analysis … By allocate operating expenses to activities that support bank customers and bank management, banks can obtain at least a rough estimate of segment net income. ,[object Object],[object Object],[object Object],[object Object],[object Object]

RAROC/RORAC analysis …RAROC refers to risk-adjusted return on capital, while RORAC refers to return on risk-adjusted capital. ,[object Object],[object Object],[object Object],[object Object]

Assigning equity capital to each unit ,[object Object],[object Object],[object Object],[object Object],[object Object]

RAROC/RORAC …often used interchangeably, but are formally defined as follows: ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Example: PNC reported results for seven distinct lines of business ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

PNC’s profitability analysis for 2000-2001

Two lines of business for PNC are detailed ,[object Object],[object Object]

PNC’s Profitability Analysis for 2000-2001 (cont.)

Transfer pricing …the interest rate at which a firm could buy or sell funds in the external capital markets. ,[object Object],[object Object]

Transfer pricing systems ,[object Object],[object Object]

Example : I nternal funds transfer pricing 2-year loan financed by a 3-month deposit

Risk-adjusted income and economic income ,[object Object],[object Object],[object Object],[object Object],[object Object]

Allocated risk capital …The objective of RAROC analysis is to assist in risk management and the evaluation of line of business performance. As part of this, it is necessary to assign capital to each line of business. ,[object Object],[object Object],[object Object],[object Object],[object Object],Unfortunately, most lines of business do not have market value balance sheets. Hence, many banks focus on the volatility in economic earnings ( earnings-at-risk ) or estimate a value-at-risk figure.

Earnings-at-risk …the volatility of earnings from a line of business. ,[object Object],[object Object],[object Object]

Earnings-at-risk applied to loans ,[object Object],[object Object],[object Object],[object Object]

Allocating risk capital based on earnings volatility: Securities underwriting and letters of credit division ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Management of market risk …market risk is the risk of loss to earnings and capital related to changes in the market values of bank assets, liabilities, and off-balance sheet positions. ,[object Object],[object Object],[object Object],[object Object]

Value-at-risk estimate for foreign exchange Identify the maximum expected loss given the bank’s recent history of daily returns on the trading portfolio. Empirical distribution approach to value-at-risk involves: 1. Identify the lowest 1 % of daily price moves. 2. Assuming that the value of the 1% lowest price move is 7.54 percent, 99 percent of the daily returns exceed this figure.

Value-at-risk estimates for market risk associated with the trading portfolios at Credit Suisse First Boston (CSFB) in 1999 and 2000.

Some analysts criticize traditional earnings measures such as ROE, ROA, and EPS because they provide no information about how a bank’s management is adding to shareholder value. ,[object Object],[object Object]

Economic value added (EVA) …an approach to measuring performance that compares a bank’s (or line of business) net operating profit after-tax (NOPAT) with a capital charge. ,[object Object]

Market and economic value added ,[object Object],[object Object],[object Object],MVA = Mkt Value of Capital - Hist. Amt of Invested Capital EVA = Net Operating Profit After Tax (NOPAT) - Capital Charge

Difficulties in measuring EVA for the entire bank ,[object Object],[object Object],[object Object]

EVA c alculation For Ameribank

EVA calculation for a meribank after sale of $1 billion in credit card loans

Balanced scorecard ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Balanced scorecard framework with four blocks ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Ch04

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