Chapter Six
Measuring and Evaluating the
Performance of Banks and Their
Principal Competitors
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Value of the Bank’s Stock

E(D t)
P0  
t
(1

r)
t 0
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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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Value of Bank’s Stock if Earnings
Growth is Constant
D1
P0 
r-g
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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 Noninteres t Income
Net Noninteres t Margin 
Total Assets
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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 Outstandin g
Total Interest Income __ Total Interest Expense
Earnings Spread = Total Earning Assets
Total Interest Bearing Liability
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Breaking Down ROE
ROE = Net Income/ Total Equity Capital
ROA =
Net Income/Total Assets
x
Equity Multiplier =
Total Assets/Equity Capital
Net Profit Margin =
Asset Utilization =
x
Net Income/Total Operating Revenue Total Operating Revenue/Total Assets
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ROE Depends On:
• Equity Multiplier
– Leverage or Financing Policies
• Net Profit Margin
– Effectiveness of Expense Management
• Asset Utilization
– Portfolio Management Policies
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Components of ROE for All
Insured U.S. Banks (1996-2005)
Year
2005
2004
2003
2002
2000
1998
ROE
12.68
13.27
15.04
14.11
13.53
13.51
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=
=
=
=
=
=
=
NPM
18.89
19.81
19.86
17.10
12.02
12.73
X
X
X
X
X
X
X
AU
6.93
6.51
6.95
7.60
9.48
9.11
X
X
X
X
X
X
X
EM
9.63
9.72
10.93
10.87
11.78
11.74
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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
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Breakdown of ROA
Net Interest Income Net Noninterest Income
ROA =

Total Assets
Total Assets
PLL-Security Gain(Losses)+Taxes-Extraordinary Gains
Total Assets
ROA = Net Interest Margin +
Net Noninterest Margin +
Special Transactions Affecting Net Income
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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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Credit Risk
The Probability that Some of the
Financial Firm’s Assets Will Decline
in Value and Perhaps Become
Worthless
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Credit Risk Measures
•
•
•
•
•
•
•
Nonperforming Loans/Total Loans
Net Charge-Offs/Total Loans
Provision for Loan Losses/Total Loans
Provision for Loan Losses/Equity Capital
Allowance for Loan Losses/Total Loans
Allowance for Loan Losses/Equity Capital
Nonperforming Loans/Equity Capital
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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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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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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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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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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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Interest Rate Risk Measures
• Interest Sensitive Assets/Interest
Sensitive Liabilities
• Uninsured Deposits/Total Deposits
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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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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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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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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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Capital Risk Measures
• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets
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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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UBPR
• The Uniform Bank Performance
Report Provided by U.S. Federal
Regulators so that Analysts Can
Compare the Performance of One
Bank Against Another
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