Evaluating Bank Performance

Outline
A Framework for Evaluating Bank Performance
Internal Performance External Performance Presentation of Bank Financial Statements

Analyzing Bank Performance with Financial Ratios

Profit Ratios Risk Ratios

Internal Performance Evaluations Based on Economic Profit

RAROC (Risk-Adjusted Return on Capital) EVA (Economic Value Added)

A Framework for Evaluating Bank Performance

Internal Performance
Bank planning (policy formulation) Goals, budgets, strategic planning Technology Computers, communications, payments Personnel development Challenges (personal selling and geographic expansion) Job satisfaction (training and compensation)

A Framework for Evaluating Bank Performance

External Performance
Market share Earnings effects Role of technology Regulatory compliance Capital Lending Securities Other Public confidence Deposit insurance Public image

A Framework for Evaluating Bank Performance

Presentation of Bank Financial Statements
Balance sheet (Report of Condition) Assets: cash assets, loans, and securities Liabilities: deposit funds and nondeposit funds Capital: equity capital, subordinated notes and debentures, loan loss reserves Income Statement (Report of Income) Interest income Noninterest income Interest expenses Noninterest expenses (including provision for loan losses) Net profit

Analyzing Bank Performance with Financial Ratios

Profit ratios
Rate of return on equity ROE = NI/TE (net income after taxes/total equity) Rate of return on assets ROA = NI/TA (net income after taxes/total assets) Other profit measures Net interest margin NIM = (Total interest income - Total interest expense)/Total assets Note: municipal bond interest is not taxable, such that it must be grossed up to a pre-tax equivalent basis by dividing munis interest earned by the factor (1 - tax rate of bank).

Analyzing Bank Performance with Financial Ratios

Profit ratios
Unraveling profit ratios ROE = ROA x TA/TE (total assets/total equity or equity multiplier).
Thus, by decreasing equity, a bank can increase ROE based on any given level of ROA.

ROE = NI/OR x OR/TA x TA/TE (where OR is operating revenue).

The NI/OR ratio is the profit margin, while OR/TA reflects asset utilization. By using this breakdown, one can make inferences concerning the reason for say increases in ROE. If asset utilization and equity multiplier did not change, the profit margin must have increased due to cost savings pushing this ratio up.

Analyzing Bank Performance with Financial Ratios

Risk ratios
Capitalization Leverage ratio Total equity/Total assets Total capital ratio (Total equity + Long-term debt + Reserve for loan losses)/Total assets

Note: book values and market values likely are different and yield different results.

 Risk ratios

Analyzing Bank Performance with Financial Ratios

Asset quality Provision for loan loss ratio = PLL/TL (provision for loan losses/total loans and leases) Loan ratio = Net loans/Total assets Loss ratio = Net charge-offs on loans (gross charge-offs minus recoveries)/Total loans and leases Reserve ratio = Reserve for loan losses (reserve for loan losses last year minus gross charge-offs plus PLL and recoveries)/Total loans and leases Nonperforming ratio = Nonperforming assets (nonaccrual loans and restructured loans)/Total loans and leases

Analyzing Bank Performance with Financial Ratios

Risk ratios
Operating efficiency (cost control) Wages and salaries/Total expenses Fixed occupancy expenses/Total expenses Liquidity Temporary investments ratio = (Fed funds sold, short-term securities, cash, trading account securities)/Total assets Volatile liability dependency ratio = (Total volatile liabilities - Temporary investments)/Net loans and leases Note: This ratio gives an indication of the extent to which hot money is being used to fund the riskiest assets of the bank.

Analyzing Bank Performance with Financial Ratios

Other financial ratios
Tax rate = Total taxes paid/Net income before taxes Dollar gap ratio = Interest rate sensitive assets - Interest-rate sensitive liabilities Total assets where rate-sensitive means short-term with maturities of less than one year (or repriced in less than one year).