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RoseHudgins: Bank

Management and Financial


Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

C H A P T E R

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

S I X

Measuring and
Evaluating the
Performance of Banks
and Their Principal
Competitors
Key Topics in This Chapter

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

61 Introduction
Humorist and poet Ogden Nash once wrote, Bankers are just like anybody else,
except richer. It turns out that statement may or may not be true; a lot depends
upon how suc-cessful bankers and other financial-service managers are as
performers in the financial marketplace. Indeed, in todays world, bankers and
their competitors are under great pres-sure to perform well all the time.
What do we mean by the word perform when it comes to financial firms? In this case
performance refers to how adequately a financial firm meets the needs of its stockholders
(owners), employees, depositors and other creditors, and borrowing customers. At the
same time, financial firms must find a way to keep government regulators satisfied that
their operating policies, loans, and investments are sound, protecting the public interest.
The success or lack of success of these institutions in meeting the expectations of others
is usually revealed by a careful study of their financial statements.
Why are financial statements under such heavy scrutiny today? One key reason is that
banks and other financial institutions now depend heavily upon the open market to raise
the funds they need, selling stocks, bonds, and short-term IOUs (including deposits). Entry

into the open market to raise money means that a financial firms financial statements will
163

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

164

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

be gone over with a fine tooth comb by stock and bond market investors, credit
rating agencies (such as Moodys and Standard & Poors), regulators, and scores
of other people and institutions.
This development has placed the management of banks and many of their competitors
under great pressure to set and meet the institutions performance goals or suffer serious
financial and reputational losses. In 2002 J. P. Morgan Chase, the second largest banking
company in the United States, became a prominent example. The firms credit rating came
under review and, for a time, it faced rising borrowing costs as major depositors and other
creditors reacted negatively to the banks potential loan losses and the adverse pub-licity
from its alleged involvement with Enron Corporation and other troubled companies.
Subsequently, J. P. Morgan Chases position strengthened and improved.
At the same time, as we saw in Chapters 14, competition for traditional loan and deposit
customers has increased dramatically. Credit unions, money market funds, insurance companies, brokerage firms and security dealers, and even chain stores are fighting for a bigger
slice of nearly every credit or deposit market. Bankers have been called upon to continually
reevaluate their loan and deposit policies, review their plans for growth and expansion, and
assess their returns and risk exposure in light of this new competitive environment.
In this chapter we take a detailed look at the most widely used indicators of the quality and
quantity of bank performance and at some performance indicators used to measure bankings
principal competitors. The chapter centers on the most important dimensions of perfor-mance
profitability and risk. After all, financial institutions are simply businesses organized to maximize
the value of the shareholders wealth invested in the firm at an acceptable level of risk. The
objectives of maximum (or at least satisfactory) profitability with a level of risk acceptable to the
institutions owners is not easy to achieve, as recent institutional failures around the globe
suggest. Aggressive pursuit of such an objective requires a financial firm to be continually on
the lookout for new opportunities for revenue growth, greater efficiency, and more effective
planning and control. The pages that follow examine the most important measures of return and
risk for banks and some of their toughest competitors.

62 Evaluating Performance
How can we use financial statements, particularly the Report of Condition
(balance sheet) and Report of Income (income statement), to evaluate how well
a financial firm is per-forming? What do we look at to help decide if a financial
institution is facing serious prob-lems that its management should deal with?

Determining Long-Range Objectives


The first step in analyzing financial statements is to decide what objectives the bank or
other financial firm is seeking. Performance must be directed toward specific objectives. A
fair evaluation of any financial firms performance should start by evaluating whether it has
been able to achieve the objectives its management and stockholders have chosen.

Certainly many financial institutions have their own unique objectives. Some
wish to grow faster and achieve some long-range growth objective. Others seem
to prefer the quiet life, minimizing risk and conveying the image of a sound
institution, but with modest rewards for their shareholders.
Maximizing the Value of the Firm: A Key Objective

for Nearly All Financial-Service Institutions


While all of the foregoing goals have something to recommend them, increasingly financial-service corporations are finding they must pay close attention to the value of their
RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 165

Key URLs
The most comprehensive sites on the World Wide Web for the
financial statements of individual banks and for the industry as a
whole are www2.fdic.gov/sdi
and www.ffiec.gov/ nicpubweb/nicweb/ nichome.aspx.

stock.
Indeed,
the basic
principle
s
of
financial
manage
ment, as
that
science
is
practice
d today,
suggest
strongly
that
attempti
ng
to
maximiz
e
a
corporati
ons
stock
value is
the key
objective
that
should
have
priority
over all
others. If
the stock
fails to
rise
in
value
commensura
te with
stockhol
der
expectati
ons,
current
investors
may
seek to
unload
their

shares and the financial institution will


have difficulty raising new capital to
support its future growth. Clearly, then,
management should pursue the objective
of maximizing the value of the financial
firms stock.

What will cause a financial firms


stock to rise in value? Each institutions
stock price is a function of the
Value of
stock
1Po 2

r
a
t
e
o
f
r
e
t
u
r
n
o
n
e
q
u
i
t
y
c
a
p
i

Expected stream
stockholder d
Discount factor

the minimum requ

t
a

where

E(Dt)
represent
s
stockhold
er
dividends
expected
to
be
paid
in
future
periods,
discounted
by
a
minimum
acceptab
le rate of
return (r)
tied
to
the
financial
firms
perceive
d level of
risk. The
minimum
acceptab
le rate of
return, r,
is
sometim
es
referred
to as an
institutions
cost
of
capital
and has
two main
compone
nts: (1)
the riskfree rate
of
interest
(often
proxied
by
the
current
yield on
governm
ent
bonds)
and (2)
the
equity
risk
premium
(which is

g
i
v
e
n
e
a
c
h
f
i
n
a
n
c
i
a
l
f
i
r
m
'
s
p
e
r
c
e
i
v
e
d
l
e
v
e
l
o
f

designed to compensate an investor for


accepting the risk of investing in a finan-cial
firms stock rather than in risk-free
securities).
The value of the financial firms stock will
tend to rise in any of the following situations:

1. The value of the stream of future


stockholder dividends is expected to
increase, due per-haps to recent
growth in some of the markets
served or perhaps because of
profitable
acquisitions
the
organization has made.

2. The financial organizations perceived level


of risk falls, due perhaps to an increase in
equity capital, a decrease in its loan losses,
or the perception of investors that the
institu-tion is less risky overall (perhaps
because it has further diversified its service
offerings and expanded the number of
markets it serves) and, therefore, has a
lower equity risk premium.

3. Market

interest rates decrease,


reducing shareholders acceptable
rates of return via the risk-free rate of
interest component of all market
interest rates.

4. Expected dividend increases are combined


with declining
investors.

risk,

as

perceived

by

Research evidence over the years has


found the stock values of financial
institutions to be especially sensitive to
changes in market interest rates, currency
exchange rates, and the strength or
weakness of the economy that each serves.
Clearly, management can work to achieve
policies that increase future earnings,
reduce risk, or pursue a combination of both
actions in order to raise its companys stock
price.

The formula for the determinants of a


financial firms stock price presented in
Equation (61) assumes that the stock
may pay dividends of varying amounts
over time. However, if the dividends
paid to stockholders are expected to
grow at a constant rate over time,
perhaps reflecting steady growth in
earnings, the stock price equation can
be greatly simplified into the form
PoD1/(rg)
where D1 is the expected dividend on
stock in period 1, r is the rate of
discount reflecting the perceived level of
risk attached to investing in the stock, g
is the

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

166

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

expected constant growth rate at which stock dividends will grow each year, and r
must be greater than g.
For example, suppose that a bank is expected to pay a dividend of $5 per share in period 1,
dividends are expected to grow 6 percent a year thereafter, and the appropriate discount rate to
reflect shareholder risk is 10 percent. Then the banks stock price must be valued at

Po

$5/(0.10

0.06)

$125 per share

The two stock-price formulas discussed above assume the financial firm will
pay div-idends indefinitely into the future. Most capital-market investors have a
limited time horizon, however, and plan to sell the stock at the end of their
planned investment horizon. In this case the current value of a financial
corporations stock is determined from
D1

D2

11 0.10 2

10.10 2

11 0.10 2

$136.78 per share

Concept Check
61.Why should banks and other corporate financial
firms be concerned about their level of profitability
and exposure to risk?
62.What individuals or groups are likely to be interested
in these dimensions of performance for a financial
institution?
63.What factors influence the stock price of a financialservice corporation?

64.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 banks perceived level
of risk is 10 percent. Can you estimate the current
value of the banks stock?

Profitability Ratios: A Surrogate for Stock Values


While the behavior of a stocks price is, in theory, the best indicator of a financial firms
performance because it reflects the markets evaluation of that firm, this indicator is often
not available for smaller banks and other relatively small financial-service corporations
because the stock issued by smaller institutions is frequently not actively traded in international or national markets. This fact forces the financial analyst to fall back on surrogates for market-value indicators in the form of various profitability ratios.

1
2
Po
1 1r 2
1 1r 2
where we assume the investor will hold the stock for n periods, receiving the
stream of div-idends D1 D2, ..., Dn, and sell the stock for price P n at the end of the
planned investment horizon. For example, suppose investors expect a bank to
pay a $5 dividend at the end of period 1, $10 at the end of period 2, and then
plan to sell the stock for a price of $150 per share. If the relevant discount rate to
capture risk is 10 percent, the current value of the banks stock should approach:
$5
$10
$150

Po

A financial calculator can be used to help solve the above equation for stock price per share where
N = 2, I/Y = 10, PV = (?), Pmt = 5, FV = 155.

1r 2

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 167

E - B AN K I N G AN D E - C O M M E R C E
benefits, but outsourcing also
Institutions

FINANCIAL FIRMS IMPROVE


PERFORMANCE BY OUTSOURCING

like

Wachovia

Bank, Bank of America, and


Germanys Deutsche Bank have

Financial firms utilize information handled by computers for nearly become leaders in the adoption of
every service they offer. As electronic data processing of financial outsourcing designed to reduce
information becomes more and more integral to the functions of the cost of operations. By outfinancial-service firms, their managers can realize cost advantages sourcing computer facilities and
from outsourcingtransferring tasks from inside the financial firm itself people, these leading financialto outside firms specializing in information technology, known as service firms hope to save money
vendors. Often the vendors are centered in distant locations, such as and time while improving overall
accuracy. Savings on personnel
China, India, and Costa Rica.
and

Factoid
Contrary to popular opinion, the largest banks
in the industry are not always the most
profitable. The same is true for the smallest
banks. The highest ROAs and ROEs often lie
among medium-size institutions.

Key
Profitability
Ratios
Among the most
important ratio
measures of
profitability
used today are
the following:

equipment

are

obvi-ous

improves
nating
financial

efficiency

dead

time

firms

by

elimi-

when

computer

equipment and staff are not being


fully

utilized.

Through

outsourcing, finan-cial institutions


are basically renting the facilities
and employ-ees of the vendor on
an as needed basis.

Return on equity capital

Net income

1ROE 2

Total equity capital


Net income

Return on assets
1ROA 2
Net interest margin

Total assets
Interest income
a Interest expense
2
Total assets

Noninterest revenues
Net noninterest
margin

Interpreti
ng
Net operating margin
Profitabili
Ratios
Earningstyper
share
Each of the

of stockforegoing
1EPS 2
Like all financial ratios, eachratios looks at
of
these
profitabilitya
slightly
measures
often
varies
substantially over time anddifferent
aspect
of
from market to market.

a Noninterest expenses
2
Total assets
profitability. has
Thus, returnbee
on
assetsn in
(ROA)
iscon
primarily anverti
indicator
ofng
managerial ass
efficiency; itets
indicates howinto
capable
net
management ear

(64)
(65)

(66)

b
(67)

nings. Return on equityand noninterest margin.


(ROE), on the otherEarning assets are those
generating interest or fee
hand, is a measure ofincome, principally loans
the rate of return and security investments.
flowing
to The reasoning is that net
interest income as well as
shareholders.
Itnet noninterest income
should be compared, not to
approximates the
all assets, but rather to
Many authorities prefer those assets that account
for the majority of all
to use total earning
assets in the denominator income.
of the net interest margin
2

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

168

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

net benefit that the stockholders have received from investing their capital in the
finan-cial firm (i.e., placing their funds at risk in the hope of earning a suitable profit).
The net operating margin, net interest margin, and net noninterest margin are
efficiency measures as well as profitability measures, indicating how well management
and staff have been able to keep the growth of revenues (which come primarily from
loans, investments, and service fees) ahead of rising costs (principally the interest on
deposits and other borrow-ings and employee salaries and benefits). The net interest
margin measures how large a spread between interest revenues and interest costs
management has been able to achieve by close control over earning assets and pursuit of
the cheapest sources of funding. The net non-interest margin, in contrast, measures the
amount of noninterest revenues stemming from service fees the financial firm has been
able to collect relative to the amount of noninterest costs incurred (including salaries and
wages, repair and maintenance of facilities, and loan-loss expenses). Typically, the net
noninterest margin is negative: Noninterest costs generally outstrip fee income, though fee
income has been rising rapidly in recent years as a percent-age of all revenues.

Another traditional measure of earnings efficiency is the earnings spread, or


simply the spread, calculated as follows:
Total interest income
Total earning assets
liabilities

Earnings
spread

Total interest expen


Total interest-bear

The spread measures the effectiveness of a financial firms intermediation function in borrowing and lending money and also the intensity of competition in the firms market area.
Greater competition tends to squeeze the difference between average asset yields and
average liability costs. If other factors are held constant, the spread will decline as
competition increases, forcing management to try to find other ways (such as generating
fee income from new services) to make up for an eroding earnings spread.
$16

million

noninterest
totaled

Concept Check
65. What is return on equity capital and what aspect of banks return on assets? Is
performance is it supposed to measure? Can you see this ROA high or low? How
how this performance measure might be useful to the could you find out?
managers of financial firms?

69. Why do the managers of

66.

assets

revenues

$2

Suppose
to $52 million. What is the

and
million.

further
amounted

that
to

$480 million, of which


earning

assets

represented 85 percent
of that total while total

Suppose a bank reports that its net income for the current financial firms often pay

interest-bearing

year is $51 million, its assets total $1,144 million, and its close attention today to the

liabilities amounted to

liabilities amount to $926 million. What is its return on equity net interest margin and

75

capital? Is the ROE you have calculated good or bad? What noninterest margin? To the
information do you need to answer this last question?
earnings spread?

assets. See if you can

percent

of

determine this banks

67. What is the return on assets (ROA), and why is Suppose


it
a banker tells you
important? Might the ROA measure be important to
that his bank in the year just
bankings key competitors?

net

68.

most recent year.

completed had total interest

A bank estimates that its total revenues will amount to $155 expenses on all borrowings
million and its total expenses (including taxes) will equal $107 of

$12

million

and

million this year. Its liabilities total $4,960 million while its noninterest expenses of $5
million, while interest income
equity capital amounts
from earning assets totaled

total

interest

and

noninterest margins and


its earnings base and
earnings spread for the

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 169

Factoid
Who must declare that a bank operating in the United States has
failed? Who usually sells or liquidates the failed institution? Answer:
A failure declaration must come from the agency issuing the banks
charter; the seller or liquidator is normally the FDIC.

Useful
Profita
bility
Formu
las for
Banks
and
Other
Finan
cialServic
e
Comp
anies
In
analyzin
g
how
well any
given
financialservice
firm
is
performi
ng, it is
often
useful to
break
down
some of
these
profitabili
ty ratios
into their
key
compon
ents. For
example
, it is
easy to
see that
ROE
and
ROA,
two
of
the most
popular
profitabili
ty
measure

s in use today, are closely related. Both


use the same numerator: net income.
Therefore, these two profit indicators can
be linked directly:

Total assets
Total equity capi

ROEROA
Or, in other words:
Net income
Total equity capital

Net income
Total assets

To
Total

But we note that net income is equal to


total
revenues
minus
operating
expenses and taxes. Therefore,

ROE

Total revenuesTotal operating


expensesTaxes
Total assets

The relationships in Equations (612)


and (613) remind us that the return to
a financial firms shareholders is highly
sensitive to how its assets are financed
whether more debt or more owners
capital is used. Even a financial
institution with a low ROA can achieve a
relatively high ROE through heavy use
of debt (leverage) and minimal use of
owners capital.
In fact, the ROEROA relationship
illustrates quite clearly the fundamental
trade-off the managers of financial-service
firms face between risk and return. For
example, a bank whose ROA is projected
to be 1 percent this year will need $10 in
assets for each $1 in capital to achieve a
10 percent ROE. That is, following
Equation (611):

T
o
t
a
l
a
s
s
e
t
s

ROE

ROA

Total equity
capital

To

0.01 $10
1
0
0

1
0
p
e
r
c
e
n
t

$
1
If, however, the banks ROA is expected to fall to 0.5
percent, a 10 percent ROE is attain-able only if each
$1 of capital supports $20 in assets. In other words:
ROE

0.005 $20 100

10
percent
$1

Indeed, we could construct a risk-return trade-off


table like the one following that will tell us how much
leverage (debt relative to equity) must be used to
achieve a financial institutions desired rate of return to
its stockholders. For example, the trade-off table on
page 170 indicates that a financial firm with a 5-to-1
assets-to-capital ratio can expect (a) a 2.5 percent
ROE if ROA is 0.5 percent and (b) a 10 percent ROE if
ROA is 2 percent. In contrast, with a 20 to 1 assets-tocapital ratio a financial firm can achieve a 10 percent
ROE simply by earning a modest 0.5 percent ROA.

Clearly, as earnings efficiency represented by


ROA declines, the firm must take on more risk in the
form of higher leverage to have any chance of
achieving its desired rate of return to its
shareholders (ROE).

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

170

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

Risk-Return Trade-Offs for Return on Assets (ROA) and Return on Equity (ROE)
ROE with an ROA of:
Ratio of Total Assets to Total
Equity Capital Accounts

0.5%

1.0%

1.5%

2.

5:1
10:1
15:1
20:1

2.5%
5.0
7.5
10.0

5.0%
10.0
15.0
20.0

7.5%
15.0
22.5
30.0

10
20
30
40

Breaking Down Equity Returns for Closer Analysis


Another highly useful profitability formula focusing upon ROE is this one:
Net income
ROE

Total operating revenue

Total operating revenue

Total assets

Total assets
Total equity capital
or
ROE Net profit margin

Asset utilization ratio

Equity multiplier

where:
The net
profit margin 1NPM 2
The degree of
asset utilization 1AU 2
The equity

Net income

Total operating reve


Total operating reve
Total assets
Total assets

multiplier 1EM 2
Total equity capital
Each component of this simple equation is a telltale indicator of a different aspect
of a financial firms operations. (See Exhibit 61.)
For example:
effectiveness of
assets.
The net profit margin
reflects
expense
leverage or

(NPM)
management (cost
financing
control)
and
service
policies: the
The degree of asset
reflects
pricing
policies.
sources chosen
utilization (AU)

portfolio
to fund the
management
financial
The equity multiplier
reflects
policies, especially
institution (debt
(EM)

the mix and yield on


or equity).
larger for most
If any of these ratios begins to decline,
banks.
Bigger
management needs to pay close attention and
banks
often
assess the reasons behind that change. For
operate
with
example, of these three financial ratios the
multipliers
of
equity multi-plier (EM), or assets to equity ratio,
20X or more.
is normally the largest, averaging about 15X or

The
multiplier is
a

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 171

EXHIBIT 61 Elements that Determine the Rate of Return Earned on the Stockholders
Investment (ROE) in a Financial Firm
Managementdecisionsregardingcapital
structure:

Rateofreturn
earnedonthe
stockholders
investment
(ROEornet
income/equity
capital)

Equitymultiplier(EM)
ortheemploymentof
financialleverageto
raisenetearnings
forthestockholders
(totalassets/
equitycapital)

What sources of funding


shouldbeused?
Whatdividendsshouldbe
paidtostockholders?

Managementdecisionsregarding:
Netprofit
margin(net
income/

Themixoffundsraisedand
invested
Howbigtheinstitutionshouldbe

operating

Returnonassets
(ROA)asameasure
ofoveralloperating
efficiency(ROA
ornet
income/totalassets)

revenues)

(NPM)

Asset
utilization
(AU)asa

Controlofoperatingexpenses
Thepricingofservices
Howtominimizethefinancialfirms
taxliability

measure
ofasset

management
efficiency
(operating
revenue/total
assets)

direct measure of
financial leverage
In the years since World War II the number how many dollars of
of U.S. banks failing annually has averaged
assets
must
be
less than 1 or 2 percent of the industry
supported by each
population.
dollar
of
equity
(owners) capital and
how much of the
financial
firms
resources, therefore,
must rest on debt.
Because equity must
absorb losses on
assets, the larger the
multiplier, the more
exposed to failure risk
the financial institution
is. However, the larger
the multiplier, the
greater the potential
for high returns for the
stockholders.
The
net
profit
margin (NPM), or the
Factoid

ratio ofincrea
net
se
income their
to totalearnin
revenue gs
s,
isand
also
the
sub-ject return
to somes
to
degree their
of
stock
manage holder
ment s by
control succe
and
ssfully
directio contro
n.
Itlling
reminds expen
us thatses
financia and
lmaxi
service mizin
corpora g
tions
reven
can
ues.

Similarly, by carefully allocating assets to the highestyielding loans and investments


while avoiding excessive risk,
management can raise the
average yield on assets (AU,
or asset utilization).

An interesting case in
point is the recent track
record of average ROE for all
FDIC-insured
depository
institutions between 1992
and 2005, shown in Table 6
1. Careful perusal of the
figures in this table reveals
very attractive ROEs for
FDIC-insured
deposi-tory
institutions covering more
than a decade. The lowest
earnings over this period for
depository institutions, as
measured by ROE, were a
very
acceptable
12.21
percent in 1992. The average
ROE
for
the
industry

gradually increased over the years,


reaching 15.04 percent in 2003 before
falling back slightly.
What created such healthy ROEs
between 1992 and 2005? Table 61
shows clearly that the primary cause
was the industrys net profit margin
(NPM), which surged upward (particularly noninterest revenues or fee
income). Operating revenues expanded
significantly faster than operating
expenses. The industrys expanding net
profit margin more than off-set
decreases in its asset utilization (AU)
ratio and equity multiplier (EM).

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

172

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

Part Two Financial Statements and Financial Firm Performance

TABLE 61
Components of Return on Equity (ROE) for All FDICInsured Institutions

(19922005)
Source: Federal Deposit
Insurance Corporation.

The McGrawHill
Companies, 2008

Year

Return on
Equity
Capital
(ROE)

2005*
2004
2003
2002
2000
1998
1996
1994
1992

12.68%
13.27
15.04
14.11
13.53
13.51
13.31
13.33
12.21

Net Profit
Margin (NPM)
(Net After-Tax
Income/Total
Revenues)

=
=
=
=
=
=
=
=
=

18.89%
19.81
19.86
17.10
12.02
12.73
12.21
12.59
9.55

Asset
Utilization (AU)
(Total
Revenues/
Total Assets)
6.93%
6.51
6.95
7.60
9.48
9.11
9.01
8.34
9.11

Equity
Multiplier (EM)
(Total Assets/
Total Equity
Capital)

9.63x
9.72x
10.93x
10.87x
11.78x
11.74x
12.17x
12.80x
13.42x

In
) to minimize tax exposure, and
this
(2) the ratio of before-tax
income to total revenue as an
case
indicator of how many dollars
Why did these latter two ratios (AU we
of
and EM) decline? The industrys assethave
utilization (AU) ratio fell mainly becausemerel
market interest rates stayed low andy split
were declining much of the time. The the
equity multiplier (EM) fell because equitynet
capital increased due to record profitsprofit
and encouragement from governmentmargi
regulators that depository institutions usen
more equity and less debt to finance their(NPM
purchases of assets. Regulators urged) into
depository institutions to increase theirtwo
capital in hopes of protecting depositorsparts:
and preserving the governments deposit(1) a
insurance reserves. At the same timetaxbanks managed to slow their assetmana
growth by making much heavier use ofgeme
off-balance-sheet transactions (as went
saw in Chapter 5) and by increasingefficie
revenues from the sale of fee-basedncy
services rather than booking so manyratio,
new assets.
reflect
A slight variation on this simpleing
ROE model produces an efficiencythe
equation useful for diagnosinguse of
problems in four different areas in the securi
management of financial-servicety
firms:
gains
or
losse
s and
Net income
other
ROE
Pretax
taxnet operating
mana
income
geme
nt
Total operating
tools
revenue
(such
Totalas
assets
buyin
or:
g taxTax
Expense exem
pt
ROEmanagementcontrolmanagementmanagement
efficiency
efficiency bonds
*Figures for 2005 are for first half only.

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Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
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Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 173

E T H I C S I N B AN K I N GAN D
F I NAN C IALS E R V I C E S
that this dual relationship
compromised the auditors
QUESTIONABLE ACCOUNTING PRACTICES CAN
judgment and discouraged
TURN BANK PERFORMANCE SOUR
them from blowing the whistle
In 2001 Superior Bank of Chicagoa federal savings bank
on the banks accounting
failed and was taken over by the Federal Deposit Insurance
problems.
The
delay
in
Corporation (FDIC). This failed banking firm provides a classic
reporting overvalua-tion of the
example of how misleading accounting practices that inflate asset
banks mortgage-related assets
values and revenues and deflate liabilities and expenses can hurt
allegedly caused the FDICs
a financial institutions performance and ultimately bring it down.
loss to eventually balloon to
In 2002 the FDIC, acting as receiver and liquidator, filed suit against
about three-quarters of a billion
the public accounting firm of Ernst and Young LLP, claiming that the
dollars. The Sarbanes-Oxley
firms auditors detected flawed accounting practices at Superior Bank,
Accounting Standards Act of
but did not report their findings until months later. Allegedly, this delay
2002 now restricts combined
on the part of the out-side auditors prevented regulators from acting
auditing
and
consulting
quickly to min-imize losses to the governments insurance fund.
relationships in order
to
Ernst and Young allegedly had both an auditorclient and a
promote auditor objectivity and
consultantclient relationship with Superior. The FDIC charged
inde-pendence. However, that
law was passed after the
Superior Bank failure occurred.

In
short,
strong
performance on the part of
financial-ser-vice providers
depends
on
honest
reporting that fairly values
current
and
expected
revenues, operating costs,
assets, and liabilities so
that both insiders and
outsiders get a clear picture
of how well a financial firm
is performing and where it
seems to be headed.
Source: Federal Deposit
Insurance Corporation.

revenue survive after operating


expenses are removeda measure
of operating efficiency and expense
control. For example, suppose a
banks Report of Condition and
Report of Income show the following
figures:
Net income
$1.0
million

Pretax net operating


income
$1.3
million

Total operating
revenue
$39.3
million

Total assets
$122.0 million

Total equity
capital
$7.3
million

Its ROE must be


ROE
ROE
16.71

$1.0 mil
$1.3 mil

0.769

0.033

$1.3 mil
$39.3 mil
0.322

0.137, or 13.7 percent

Clearly, when any one of these four


ratios begins to drop, management
needs to reevaluate the financial
firms efficiency in that area. In the
banking example shown above, if the
ratio of net income to pretax net
operating income falls from 0.769 to
0.610 next year, management will
want to look closely at how well the
banks tax expo-sure is being
monitored and controlled. If pretax net
operating
income
to
operating
revenue drops from 0.033 to 0.025 in
the coming year, the banks
effectiveness in con-trolling operating
expenses needs to be reviewed. And
if the ratio of operating revenues to
assets plummets from 0.322 to 0.270,
a careful reexamination of asset
portfolio poli-cies is warranted to see
if the decline in asset yields is due to
factors within manage-ments control.

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

174

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

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Companies, 2008

Part Two Financial Statements and Financial Firm Performance

Breakdown Analysis of the Return on Assets


We can also divide a financial firms return on assets (ROA) into its component parts,
as shown in Table 62. Actually, ROA is based on three simple component ratios:

Components of ROA
Net interest margin 1Interest income Interest expense 2
Total assets
PLUS
1Noninterest income 2
Noninterest expense 2
Total assets

Net noninterest margin

LESS
Provision for loan losses
Special transactions

; securities gains 1or losses 2


taxesextraordinary net gains
Total assets

affecting its net


income
Return on assets 1ROA, 2
or the ability of
management to generate income

EQUALS
Net income
Total assets

from assets 2
Such a breakdown of the components of return on assets (ROA) can be very helpful in
explaining some of the recent changes that financial-service providers have experienced
in their financial position. For example, as shown in Table 63, the average ROA for all
FDIC-insured institutions between 1992 and 2005 rose from 0.87 percent in 1992 to a high
of 1.38 percent in 2003 before leveling out in 2004 and 2005.
Why did ROA for 19922003 keep getting better and better? Better control over
expenses, led by advances in automation and mergers that eliminated many overlapping
facilities, along with an expanding economy, which propelled upward the publics demand
for financial services, resulted in a rapid expansion of fee (noninterest) income and loan
revenues. All this occurred in the face of falling market interest rates, which
Total assets

TABLE 62
Calculation Return on Assets (ROA)

Gross
interest
income
Total
assets

Interest
expens
e

Total
assets

1=
Net
inter
est
mar
gin

Income taxes
Total assets*

2=

Noninterest income
Total assets

Noninterest
expenses Total
assets

Provision for
loan losses Total
assets

3=

1=

Pretax
net
operating
income Total
assets

Income
before
extraordinary
items Total assets +
Extraordinary
net
gains Total assets

Net income
Total assets (or
ROA)

(620

1d
2d
3d
4d
5d
6d

7d
Income from holding assets
Supply cost of funds for holding assets
Return earned because the lending institutions credit
quality is better than its customers credit quality
Income from handling customer transactions

Cost of operations
Accrual expense

*Both income and taxes applicable to income need to be adjusted for


any tax-exempt earnings received. One can restate such income on
a fully tax-equivalent basis by multiplying the amount of tax-exempt
income by the expression 1 (1 t) where t is the firms tax bracket
rate.

Re
tur
n
on
as
set
s
bef
or
e
tax
es

8d

9d

The
financial
firms
share of
the cost
of
govern
ment
services
Net

income

from
recurring
sources
of
revenue

10d Nonrecurring

sources
of
income or loss

11d Earnings

left
over for the
stockholders
after all costs
are met

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Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 175
+ Securities gains(losses)/
Income Statement
Items
Total assets
0.06
0.13
TABLE 63
Total interest income/
Applicable income taxes/
Components of Return on Assets (ROA) for All FDIC
Total assets Total assets
0.64
0.67
Insured Depository
Total interest =expense/
Income before extraordinary
Total assets items/Total assets
Institutions (19922005)
1.31
1.37
= Net interest income/
+ Extraordinary gains (net)/
Source: Federal Deposit
Total assets Total assets
0.00** 0.00**
Insurance Corporation.
Provision for =loan
Netand
income/Total assets
1.31
1.38
lease losses/Total assets
+ Total noninterest
income/
Notes: Figures
may not add
Total assets exactly to totals due to
rounding
and the exclusion
Total noninterest
expense/
of extraordinary items. *2005
Total assets figures are for first half of
= Pretax net operating
year only. income/
Total assets **Less than 0.005 percent.

lowered bankings ratio of gross


interest income to total assets and
reduced its net inter-est margin. The
decline in banks net interest
earnings was more than made up for,
how-ever, by dramatic increases in
their fee income and improved loan
quality as reflected in somewhat
smaller loan-loss expenses. By 2003
the industrys ROA, averaging 1.38
per-cent, represented the biggest
average rate of return on bank assets
since the FDIC began its operations
in 1934.

0.15

0.02

0.64

0.61

1.30

1.14

0.00**
1.30

0.00**
1.14

Concept Check
611.

What

are

the

Exp

aspects of a financial
institutions
performance
do
they
reflect?

principalens

615. If a bank has a net interest

components of ROE ande


what does each of thesecon
components measure?

trol
612. Suppose a bank haseffi
an ROA of 0.80cie
percent and an equityncy
multiplier of 12. Whatindi
is its ROE? Supposecat
this banks ROA falls toor?
0.60 percent. WhatAss
size equity multiplieret
must it have to hold itsma
nROE unchanged?
613. Suppose a bank reports net age
income of $12, pretax netme
income of $15, operatingnt
revenues of $100, assets of effi
$600, and $50 in equitycie
ncy
capital. What is the banks
indi
ROE?
Tax-management
cat
efficiency indicator?
or?
Fun
ds
ma
nag
em
ent
effi
cie
ncy
indi
cat
or?
Wh
at
are
the
mo
st
imp
orta
nt
co
mp
one
nts
of
RO
A
and
wh
at

margin of 2.50%, a noninterest margin of 1.85%,


and a ratio of provision for
loan losses, taxes, security
gains, and extraor-dinary
items of 0.47%, what is
its ROA?

What a
Breakdown of
Profitability
Measures Can
Tell Us
Clearly, breaking down
profitability measures into
their respective
components tells us much
about the causes of
earnings difficulties and
suggests where
management needs to
look for

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

176

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

Part Two Financial Statements and Financial Firm Performance

possible

Factoid

The McGrawHill
Companies, 2008

cures for

Which banks in the industry tend to have the biggest net interest any
margins between their interest income from loans and securities
and the interest cost of borrowed funds? Answer: The smallest earnings
banks usually do.
problems

that
surface.
The
foregoing
analysis
reminds
us that
achieving
superior
profitabilit
y for a
financial
institution
depends
upon
several
crucial
factors:

1. Caref
ul
use
of
finan
cial
lever
age
(or
the
prop
ortio
n of
asset
s
finan
ced
by
debt
as
oppo
sed
to
equit

y capital).

2. Careful use of operating leverage


from fixed assets (or the proportion
of fixed-cost inputs used to boost
operating earnings as output grows).

3. Careful

control
of
operating
expenses so that more dollars of
sales revenue become net income.

4. Careful management of the asset


portfolio to meet liquidity needs while
seeking the highest returns from any
assets acquired.

5. Careful control of exposure to risk so


that losses dont overwhelm income
and equity capital.

Measuring Risk in Banking


3
and Financial Services

Market
Operational
Legal
Reputation

Risk to the manager of a financial institution


or to a regulator supervising a financial
institu-tion means the perceived uncertainty
3
associated with a particular event. For This
section
example, will the customer renew his or her is
loan? Will deposits and other sources of based,
in part,
funds grow next month? Will the financial on
firms stock price rise and its earnings Peter
increase? Are interest rates going to rise or S.
Roses
fall next week, and will a financial institution article
in the
lose income or value if they do?
Canadi

Bankers, for example are usually an


interested in achieving high stock values Banker
[3] and
and high profitability, but none can fail to is used
pay attention to the risks they are with
permis
accepting to achieve these goals. sion.
Earnings may decline unexpectedly due
to factors inside or outside the finan-cial
firm, such as changes in economic
conditions, competition, or laws and
regulations.
For
example,
recent
increases in competition have tended to
narrow the spread between earnings on
assets and the cost of raising funds.
Thus, stockholders always face the
possi-bility of a decline in their earnings
per share of stock, which could cause the
banks stock price to fall, eroding its
resources for future growth.
Among the more popular measures of
overall risk for a financial firm are the
following:

1 Standard deviation () or variance


2

( ) of stock prices.
2 Standard deviation or variance of
net income.

3 Standard

deviation or variance of
return on equity (ROE) and return on
assets (ROA).

The higher the standard deviation or


variance of the above measures, the
greater the overall risk. Risk can be
broken down into a number of
components and even referenced
using different terms as illustrated by
the different risk matrices used
currently by U.S. fed-eral regulatory
agencies and summarized below.
Risk Matrices Used by Selected U.S.
Regulatory Agencies
Federal Reserve System

Comptroller of the Currency

Credit
Liquidity

Credit
Liquidity

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Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Insights and Issues


Employee
productivity
tends to be higher among top
A number of research studies have examined top-earning firms in earners. For example, banks
the banking industry in an effort to answer a simple question:
with the best profits seem to
What distinguishes a bank with above-average profitability generate and manage more
from banks that are only average performers? How did top-assets and income per
employee and pay their more
earning banks get that way?
Bank size is clearly one factor. The top-earning banks in the productive employees higher
industry, at least as measured by their ROA and ROE, are often salaries.

HOW TOP-EARNING BANKS GET THAT WAY

Leverage
(lower
equity
medium-size or larger institutions that seem to benefit from lower
capital and greater use of debt)
overall operating costs and greater operating efficiency.
Expense control stands out as the most important discrimina-tor also emerges as a profit
between top performers and the also-rans. For example, high-profit motivator. Top-earning banks, for
banks manage their operating expenses better, generally posting example, generally economize
lower average interest costs, and especially lower per-sonnel on using high-cost owners
expenses and overhead. Their ratios of operating expenses to capital and rely on the earningsoperating revenues tend to be significantly below the expense-to- leveraging effects of cheaper
debt.
revenue ratios of low-profit institutions.
The deposit structure also appears to influence profit perforThe expansion of fee
mance. Top-earning banks often hold more demand deposits than income has become a key
other banks; these checkable deposits pay little or no interest and element in strategies to
carry customer service fees that bring in more revenues. Relat-edly, increase profits in recent
many highly profitable banks hold a large volume of core depositsyears. Government deregulasmaller denomination deposits from individuals and smalltion has put added pressure
businesses that pay low interest rates and are more loyal to the on financial institutions to
charge fees for many
bank than larger deposit accounts.

formerly free services and


develop new fee-generating
services.
Growth in assets, deposits, and
loans seems to play a role because
top-earning banks seem to grow
faster

than

average,

pos-sibly

reflecting the presence of more


aggressive management or greater
customer

acceptance

of

their

services. However, growth should


not become a substitute for profits.
Top-earning
recognize

banks
that

seem

growth

can

to
be

overdone, resulting in uncontrolled


expansion that increases operating
expenses faster than revenues.
Moderate growth is usually a better
route to high profits.
For further information on the
characteristics of high-profit banks
see especially Elizabeth C. Klee
and Fabio M. Natalucci, Profits
and Balance Sheet Developments
at

U.S.

Commercial

Banks

in

2004, Federal Reserve Bulletin,


Spring 2005, pp. 14374.

Each of these forms of risk can


threaten a financial firms day-to-day
performance and its solvency and
long-run survival. Lets examine now
several of the most important types
of risk encountered daily by financial
institutions.

Credit Risk
The probability that some of a
financial institutions assets, especially
its loans, will decline in value and
perhaps become worthless is known
as credit risk. Because financial firms
tend to hold little owners capital
relative to the aggregate value of their
assets, only a small percentage of
total loans needs to turn bad to push
them to the brink of failure. The
following are four of the most widely
used indicators of credit risk:

1 The ratio of nonperforming assets


to total loans and leases.

2 The ratio of net charge-offs of


loans to total loans and leases.

3 The ratio of the annual provision


for loan losses to total loans and
leases or to equity capital.

4 The

ratio of allowance for loan


losses to total loans and leases or
to equity capital.

5 The ratio of nonperforming assets


to equity capital.
Nonperforming
assets
are
incomegenerating assets, including loans, that are
past due for 90 days or more. Charge-offs,
on the other hand, are loans that have
been declared worth-less and written off
the lenders books. If some of these loans
ultimately generate income, the amounts
recovered are deducted from gross
charge-offs to yield net charge-offs. As
these ratios rise, exposure to credit risk
grows, and failure of a lending institution
may be

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Services, Seventh Edition

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II. Financial Statements


and Financial Firm
Performance

6. Measuring and
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Performance of Banks and
Their Principal
Competitors

The McGrawHill
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Part Two Financial Statements and Financial Firm Performance

just around the corner. The final two credit risk indicator ratios reveal the extent to
which a lender is preparing for loan losses by building up its loan-loss reserves
(the allowance for loan losses) through annual charges against current income
(the provision for loan losses).
Another popular and long-standing credit risk measure is:
The ratio of total loans to total deposits.
As this ratio grows, examiners representing the regulatory community may
become more concerned because loans are usually among the riskiest of all
assets for depository institu-tions, and, therefore, deposits must be carefully
protected. A rise in bad loans or declining market values of otherwise good loans
relative to the amount of deposits creates greater depositor risk.

Liquidity Risk
Financial-service managers are also concerned about the danger of not having sufficient
cash and borrowing capacity to meet customer withdrawals, loan demand, and other cash
needs. Faced with liquidity risk a financial institution may be forced to borrow emergency
funds at excessive cost to cover its immediate cash needs, reducing its earnings. Very few
financial firms ever actually run out of cash because of the ease with which liquid funds
can be borrowed from other institutions. In fact, so rare is such an event that when a small
Montana bank in the early 1980s had to refuse to cash checks for a few hours due to a
tem-porary cash-out, there was a federal investigation of the incident!

Somewhat more common is a shortage of liquidity due to unexpectedly heavy


deposit withdrawals, which forces a depository institution to borrow funds at an
elevated interest rate, higher than the interest rates other institutions are paying for
similar borrowings. For example, significant decline in its liquidity position often forces
a bank to pay higher inter-est rates to attract negotiable money market CDs, which
are sold in million-dollar units and therefore are largely unprotected by deposit
insurance. One useful measure of liquid-ity risk exposure is the ratio of

1 Purchased funds (including Eurodollars, federal funds, security RPs, large


CDs, and commercial paper) to total assets.
Heavier use of purchased funds increases the chances of a liquidity crunch in the
event deposit withdrawals rise or loan quality declines. Other indicators of
exposure to liquidity risk include the ratios of

1 Cash and due from balances held at other depository institutions to total assets.
2 Cash assets and government securities to total assets.
Cash assets include vault cash held on the financial firms premises, deposits held with
the central bank in the region, deposits held with other depository institutions to compensate them for clearing checks and other interbank services, and cash items in the
process of collection (mainly uncollected checks). Standard remedies for reducing a financial institutions exposure to liquidity risk include increasing the proportion of funds committed to cash and readily marketable assets, such as government securities, or using
longer-term liabilities to fund the institutions operations.

Market Risk
In market-oriented economies, where most of the worlds leading financial institutions offer
their services today, the market values of assets, liabilities, and net worth of financialservice providers are constantly in a state of flux due to uncertainties concerning market

rates or prices. Market risk is composed of both price risk and interest rate risk.
RoseHudgins: Bank
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Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
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Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 179

Price Risk
Especially sensitive to these market-value movements are bond portfolios and
stockhold-ers equity (net worth), which can dive suddenly as market prices move
against a finan-cial firm. Among the most important indicators of price risk in
financial institutions management are

1 The ratio of book-value assets to the estimated market value of those same assets.
2 The ratio of book-value equity capital to the market value of equity capital.
3 The market value of bonds and other fixed-income assets held relative to their
value as recorded on a financial institutions books.

4 The market value of common and preferred stock per share, reflecting investor
per-ceptions of a financial institutions risk exposure and earnings potential.

Interest Rate Risk


Movements in market interest rates can also have potent effects on the margin of
revenues over costs for both banks and their competitors. For example, rising interest
rates can lower the margin of profit if the structure of a financial institutions assets
and liabilities is such that interest expenses on borrowed money increase more
rapidly than interest rev-enues on loans and security investments.

The impact of changing interest rates on a financial institutions margin of profit


is called interest rate risk. Among the most widely used measures of interestrate risk expo-sure are these:

1 The ratio of interest-sensitive assets to interest-sensitive liabilities: when


interest-sensi-tive assets exceed interest-sensitive liabilities in a particular
maturity range, a financial firm is vulnerable to losses from falling interest
rates. In contrast, when rate-sensitive liabilities exceed rate-sensitive assets,
losses are likely to be incurred if market interest rates rise.

2 For a depository institution, the ratio of uninsured deposits to total deposits,


where uninsured deposits are usually government and corporate deposits that
exceed the amount covered by insurance and are usually so highly sensitive
to changing interest rates that they will be withdrawn if yields offered by
competitors rise even slightly higher.
With more volatile market interest rates in recent years, bankers and their competitors
have developed several new ways to defend their earnings margins against interest-rate
changes, including interest-rate swaps, options, and financial futures contracts. We will
examine these and other risk-management tools in Chapters 7, 8, and 9.

Operational (Transactional) Risk


Operational risk refers to uncertainty regarding a financial firms earnings due to failures
in computer systems, errors, misconduct by employees, floods, lightning strikes, and
similar events. The broad group of actions included in this risk definition often decrease
earnings due to unexpected operating expenses. Some analysts say that operational risk
is the risk of loss due to anything other than credit or market risk. Others say it includes
legal and com-pliance risk, but not reputation or strategic risk. The consolidation and
convergence of finan-cial firms and the complexity of todays financial-services technology
has made operational risk a broad risk category that needs to be addressed by both
managers of financial firms and government regulators.

As technology has improved, computer hardware and software systems have become
essential to the daily operations of most financial firms. If computer systems involve a
patchwork of old programs, requiring employee intervention to reconcile and create
RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

180

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

Key URLs
Many of the types of risk discussed in this section have been developed
and refined by the Bank for International Settlements at www.bis.org and
by a related entity, the Basel Committee on International Capital
Standards, at www.bis.org/publ/bcbs/

107.htm, which is explored in detail in Chapter 15.

reports,
then
operatio
nal risk
may be
high.
While
the
failure
of
a
new
comput
er
system
may be
less
likely,
heavy
reliance
by the
institutio
ns
personn
el and
custom
ers on
such
systems
creates
vulnera
bility for
any
financial
firm.
Today
, acts of
terrorism
such as
9/11 and
natural
disasters
such as
hurricane
s, earthquakes,
and
tsunamis
can lead

to great loss for any financial firm. These


natural and not-so-natural disasters may
close financial institutions for extended
periods and interrupt their service to
customers. Foregone income from such
disasters is unpredictable, resulting in
unexpected operating expenses and greater
variability in earnings.

Financial fraud provides the plots for


great movies, such as Rogue Trader, The
Bank, and Boiler Room, and the basis for
many 60 Minutes episodes. Its about
money, stealing, and the ultimate failure
of some at-risk institutions. A financial
firms owners, employees, cus-tomers, or
outsiders may violate the law and
perpetrate
fraud,
forgery,
theft,
misrepresenta-tion, or other illegal acts,
sometimes leading to devastating losses
to otherwise well-managed financial
institutions.

Legal and Compliance Risks


Legal risk creates variability in earnings
resulting from actions taken by our legal
system.
Unenforceable
contracts,
lawsuits, or adverse judgments may
reduce a financial firms rev-enues and
increase its expenses. Lawyers are never
cheap and fines can be expensive! In a
broader sense compliance risk reaches
beyond violations of the legal system and
includes
violations
of
rules
and
regulations. For example, if a depository
institution fails to hold adequate capital,
costly corrective actions must be taken to
avoid its closure. These cor-rective
actions are laid out in capital adequacy
regulations and are examined in more
detail in Chapter 15.

Reputation Risk
Negative publicity, whether true or not,
can affect a financial firms earnings by
dissuading customers from using the
services of the institution, just as positive
publicity may serve to promote a financial
firms services and products. Reputation

risk is the uncertainty associ-ated with public opinion. referred


The very nature of a financial firms business requires to as its
maintain-ing the confidence of its customers and capital
risk.
creditors.

Becaus
e
Variations in earnings due to adverse business variabilit
decisions, improper implementation of deci-sions, or y
in
lack of responsiveness to industry changes are parts capital
of what is called strategic risk. This risk category canstems
be characterized as the human element in making bad from
long-range management decisions that reflect poor other
timing, lack of foresight, lack of persistence, and lack types of
risk it is
of determination to be successful.
often
Capital Risk
not
The impact of all the risks examined above can conside
affect a financial firms long-run survival, often red

Strategic Risk

separately by government regulatory


agencies. However, risks to the capital
that underlies every financial firm
captures the all-important risk of insolvency or ultimate failure.
For example, if a bank takes on an
excessive number of bad loans or if a
large portion of its security portfolio
declines in market value, generating
serious capital losses when sold, then
its equity capital account, which is
designed to absorb such losses, may
be over-whelmed. If investors and
depositors become aware of the
problem and begin to withdraw their
funds, regulators may have no choice
but to declare the institution insolvent
and close its doors.

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 181

Filmtoid
What 2000 film stars Paul Newman as an incarcerated bank
robber who had stolen millions from the banks to which he sold
and installed security systems and then returned to rob them?

Answer: Where the Money Is.

The
failure of
a
financialservice
corporati
on may
leave its
stockhol
ders with
none of
the
capital
they
committe
d to the
institutio
n.
Moreove
r, in the
case of
deposito
ry institutions,
deposito
rs
not
covered
by
insuranc
e
also
risk
losing a
substanti
al
portion
of their
funds.
For this
reason,
the
prices
and
yields on
capital
stock
and on
large
uninsure
d
deposits
can
serve as

an early warning sign of solvency problems.


When investors believe that a financial firm
has an increased chance of failing, the
market value of its capital stock usually
begins to fall and it must post higher interest
rates on its borrowings in order to attract
needed funds. Economists call this
phenomenon market discipline: interest
rates and security prices in the financial
marketplace move against the troubled firm,
forcing it to make crucial adjustments in
policies and performance in order to calm
investors worst fears. This suggests that
capital risk can be measured approximately
by such factors as

1 The

interest rate spread between market

yields on debt issues (such as capital notes


and CDs issued by depository institutions)
and the market yields on government
securities of the same maturity. An increase
in that spread indicates that investors in the
market ex-pect increased risk of loss from
purchasing and holding a financial
institutions debt.

2 The ratio of stock price per share to


annual earnings per share. This ratio
often falls if investors come to
believe that a financial firm is
undercapitalized relative to the risks
it has taken on.

3 The

ratio of equity capital (net worth) to

total assets, where a decline in equity


funding relative to assets may indicate
increased risk exposure for shareholders
and debtholders.

4 The ratio of purchased funds to total


liabilities. Purchased funds usually
include unin-sured deposits and
borrowings in the money market from
banks, nonbank corporations, and
governmental units that fall due
within one year.

5 The ratio of equity capital to risk


assets, reflecting how well the
current
level of a fi-nancial
institutions capital covers potential
losses from those assets most likely
to de-cline in value.
Risk assets consist mainly of loans and

securities and exclude cash, plant and equipment, andof


miscellaneous assets. Some authorities also exclude depositor
holdings of short-term government securities from risk assets y
because the market values of these securities tend to be institution
stable and there is always a ready resale market for them. s
has
Concern in the regulatory community over the risk exposure resulted

in heavy pressure on their management to


increase capital. As we saw earlier in this
chapter, capital, at least in the banking
industry, has moved significantly higher
relative to the industrys assets and liabilities in
recent years.

y-market borrowings total $132


million,

while

nonperforming

loans currently amount to $43

Concept Check
mated

million and the bank just charged

616. To what different kinds of risk are marke

off $21 million in loans. Calculate

banks and their financial-servicet

as many of the risk measures as

competitors subjected today?

you can from the foregoing data.

value

What items on a banks balances of


the
sheet and income statement can be
bank
used to measure its risk expo-sure?
s total
To what other financial institutions
asset
do these risk measures seem to
s and
apply?
equity
618. A bank reports that the total amount
capita
of its net loans and leases
l are
outstanding is $936 million, its
$1,44
assets total $1,324 million, its
3
equity capital amounts to $110
millio
million, and it holds $1,150 million
n and
in deposits, all expressed in book$130
617.

value. The esti-

millio
n,
respe
ctively
. The
bank
s
stock
is
curre
ntly
value
d

at

$60
per
share
with
annua
l pershare
earnin
gs of
$2.50.
Unins
ured
depos
its
amou
nt

to

$243
millio
n and
mone

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

182

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Performance

Other
Key URLs
Goals
Performance data on bankings closest competitors
in
nonbank depository institutionscan most easily be found at
such Web sites as www.ots.treas.gov, www.fdic.gov, and Banki
www.ncua.gov.
ng
and
Finan
cialServic
es
Manag
Factoid
ement

Which banks tend to be most efficient in controlling costs and


In
an
revenues? Answer: Usually medium-size and larger
effort
to
institutions (over $100 million in assets).
maximize
profitabilit
y and the
value of
the
sharehold
ers
investme
nt in a
finan-cial
institution,
many
financial
firms
recognize
the need
for
greater
efficiency
in
their
operations.
This
usually
means
reducing

63
Perf
lowe
r

Factoid
In recent years FDIC-insured
savings associations (savings and
loans and savings banks) have had

operating expenses and increasing the


productivity of their employees through the use
of automated equipment and improved
employee
training.
The
government
deregulation movement has forced depository
institutions, for example, to pay higher interest
costs for their funds and encouraged
management to reduce noninterest costs,
especially employee salaries and benefits and
overhead costs. Among the most revealing
mea-sures of operating efficiency and
employee productivity for a financial institution
are its

Total opera

Operating efficiency ratioTotal o


N
et operating income

Employee productivity ratio


Number of full-time-equivalent
employees
Not all financial firms pursue high
profitability, maximum stock values, increased
growth, or greater efficiency as key goals,
however. There is considerable evidence that
some institutions prefer greater market power
in the markets they serve, not only because it
gives them increased control over prices and
customer relationships, but also because a
financial-service provider with greater market
influence can enjoy a more quiet life, or face
less risk of losing earnings or market share.
Several recent studies have found, for example, that some banks in this situation display
expense preference behavior: They spend
more on salaries and wages of management
and staff, enjoy more fringe benefits, or build
larger
and
more
sumptuous
offices.
Unfortunately for the stockholders of these
institutions, a preference for expenses
sacrifices profits and limits potential gains in
stock values.

ormance Indicators
Competitors
among Bankings Key

Many
of
thebanks
and
theirincl
performance
nonbank competitors.udi
indicators discussed inThis is espe-cially trueng
the foregoing sectionsof
those
nonbanksto
apply equally well forfinancial
institutionsckh
measuring
thethat are private, profit-old
performance of bothmaking corpora-tions,er-

owned
thrift
institutions, insurance
companies,
finance
and
credit-card
companies, security
broker and dealer
firms, and mutual

perf ance indicators thatapplicable to pri-ma


Among the key bankorm often are equallyvately owned, profit-kin
assets and equity returns
P
stock
E
Return on
than insured commercial
a
r
Return on
equity
u
banks, but not by much. For
r
i
assets
capital
t
example, for all of 2004
n
(ROA)
(ROE)
commercial banks reported c
i
an average ROA of 1.31
i
e
N
Net
l
percent versus 1.17 percent
n
s
operating
e
i
for savings associations and
g
margin
t
an average ROE of 13.80
z
s
o
percent versus
Equity
a
n
multiplier
i
t
p
Cash
n
i
e
c
accounts to
t
r
o
o
total assets
e
n
m
Interests
r
m
sensitive
h
e
o
r
assets to
a
s
n
a
interestr
t
t
sensitive
e
a
liabilities
i
n
m
Interest-rate
o
o
d
a
spread between
f
Nonperforming
funds.

p
r
e
f
e
r
r
e
d
10.87 percent for
S
savings associations. o
Why do you think these
m
differences exist?

r
g
i
n

assets to equity
capital ratio

Book-value
assets to
market-value
assets Equity
capital to
risk-exposed
assets

A
s
s
e
t

each nonbank
financialservice

industry.

example,

er

among

fo

insurance

companies,

key

performance

nc

measures

include

in

growth of net

di

premiums

ca

written

to

measure

rs

total

ar

and the size of

life

pension

ni

reserves (their

q
u
e
to

For

the

(a
of
sales)
and

s
t
o
c
k

yields on the
financial firms
debt and market
yields on
government
securities

g nonbank financial
firms are these:

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 183

chief liabilities) relative to total assets. Insurers also pay close attention to an
efficiency measurethe combined ratio of claims paid out plus operating
expenses relative to premi-ums earned from policyholders.
Among mutual funds, key performance markers include the growth of net sales
(i.e., gross sales of shares less share redemptions by the public), service fees
relative to aver-age assets, and the rate of return on funds invested. In contrast,
finance and credit-card companies often pay close attention to the growth of their
outstanding debt and their gross receivables (a measure of total loans extended to
customers). Finally, among com-peting depository institutions, such as credit unions
and mutual savings associations, key performance measures include total loans to
members relative to capital reserves (a measure of risk), home mortgage loans to
total assets (a rapidly growing credit ser-vice), and the number of actual members
(customers) relative to potential members (customers).

No financial institution can safely ignore its level of performance today relative
to its past performance and relative to its competitors. Even if some financialservice institu-tions dont seem to care about their performance, both the public
and the regulatory com-munity clearly do.

64 The Impact of Size on Performance


When the performance of one financial firm is compared to that of another, sizeoften
measured by total assets or, in the case of a depository institution, total deposits
becomes a critical factor. Most of the performance ratios presented in this chapter are
highly sensi-tive to the size group in which a financial institution finds itself.

Thus, size bias is especially evident in the banking industry. For example, as
Table 64 shows, key earnings and risk measures change dramatically as we move
from the smallest banks (those in the table with assets of less than $100 million) to
the largest banking firms (with assets exceeding $10 billion). For example, the most
profitable banks in terms of ROA were banks with more than $1 billion in assets and
less than $10 billion in assets, while the largest equity returns (ROE) were obtained
by the very largest banks with more than $10 billion in assets in 2005.

On the other hand, middle-size and large banks with assets ranging from $100
mil-lion to $10 billion in total assets often display the most favorable net operating
margins and the best operating efficiency (often with the lowest operatingexpense-to-revenue ratio). Similarly, the largest banks generally report the
highest (least negative) nonin-terest margins because they charge fees for so
many of their services. Smaller and medium-size banks frequently display larger
net interest margins and, therefore, greater spreads between interest revenue
and interest costs because most of their deposits are small-denomination
accounts with lower average interest costs. Moreover, a larger proportion of small
and medium-size banks loans tend to be higher-interest consumer loans.
In terms of balance-sheet ratios, many of which reflect the various kinds of risk exposure banks face, the smallest banks usually report higher ratios of equity capital to assets.
Some bank analysts argue that larger banks can get by with lower capital-to-asset
cushions because they are more diversified across many different markets and have more
risk-hedg-ing tools at their disposal. Smaller banks appear to be more liquid, as reflected
in their lower ratios of net loans to deposits, because loans are often among a banks least
liquid assets. The biggest banks also appear to carry greater credit risk as revealed by
their higher loan-loss (net charge-offs to total loans and leases) ratios.
RoseHudgins: Bank

II. Financial Statements

6. Measuring and

The McGrawHill

Management and Financial


Services, Seventh Edition

184

and Financial Firm


Performance

Evaluating the
Performance of Banks and
Their Principal
Competitors

Companies, 2008

Part Two Financial Statements and Financial Firm Performance

TABLE 64 Important Performance Indicators Related to the Size and Location of FDIC-Insured Banks (2005) *
Source: Federal Deposit Insurance Corporation.

Return on assets (ROA)


Return on equity (ROE)
Net operating income to assets
Net interest margin
Net noninterest margin
Efficiency ratio
Credit loss provision to net
charge-offs
Net charge-offs to loans
Loss allowance to loans
Noncurrent assets plus other real
estate owned to assets
Net loans and leases to deposits
Equity capital to assets
Yield on earning assets
Cost of funding earning assets
Noninterest income to earning
assets

Average for
All FDICInsured
Institutions

Average for
All FDICInsured
Banks

Banks Arrayed by Total Assets in the Size Range


Under
$100
$1 Billion
Greater
$100
Million
to $10
than $10
Million
to $1 Billion
Billion
Billion

1.31%
12.68
1.27
3.51
1.05
57.35

1.34%
13.12
1.32
3.59
1.01
57.36

1.05%
8.84
1.05
4.23
2.60
68.74

92.44
0.44
1.23

91.34
0.50
1.38

183.09
0.16
1.43

148.82
0.20
1.32

115.34
0.26
1.31

85.47
0.60
1.40

0.48
92.74
10.38
5.50
1.99

0.50
87.29
10.23
5.52
1.94

0.72
74.21
11.87
5.89
1.66

0.56
83.22
10.13
6.05
1.80

0.45
92.01
10.87
5.70
1.82

0.49
87.76
10.10
5.40
1.99

2.45

2.69

1.02

1.46

2.15

3.02

1.33%
13.15
1.32
4.25
2.09
61.67

1.41%
13.09
1.41
3.89
1.35
56.80

1.34%
13.26
1.32
3.42
0.74
56.56

Notes: Data for all U.S. commercial banking and savings institutions whose deposits are
FDIC insured. *Figures shown are for the first 2 quarters of 2005 and are annualized.

Size, Location, and Regulatory Bias in Analyzing the


Performance of Banks and Competing Financial Institutions
As we saw in the preceding section, the size of a financial institution (often measured by
its assets, deposits, or equity capital) can have a highly significant impact on profitability
and other performance measures. For example, when we compare the performance of
one financial firm with another, it is best to compare institutions of similar size. One reason
is that similar-size financial firms tend to offer the same or similar services, so you can be
a bit more confident that your performance comparisons have some validity.
To conduct even more valid performance comparisons, we should also compare financial firms serving the same or similar market areas. Performance is usually greatly influenced by whether a financial-service provider operates in a major financial center, smaller
city, or rural area. The best performance comparison of all is to choose institutions of similar size serving the same market area. Unfortunately, in some smaller communities it may
be difficult, if not impossible, to find another financial firm comparable in size. The financial analyst will then usually look for another community with a similar-size financial institution, preferably a community with comparable businesses and households because the
character of a financial firms customer base significantly impacts how it performs.
Finally, where possible, its a good idea to compare financial institutions subject to similar
regulations and regulatory agencies. For example, in the banking community each regulator
has a somewhat different set of rules banks must follow, and these government-imposed rules
can have a profound impact on performance. This is why comparison of financial firms in
different countries is often so difficult and must be done with great caution.
Even in the United States, with so many different regulatory agencies, analysts often stress
the importance of comparing member banks of the Federal Reserve System against other
member banks of the Federal Reserve System. Similarly, the performance of national

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Insights and Issues


BankWatchs credit ratings
are among the most widely
CREDIT RATINGS BY THOMSONS BANKWATCH, INC. followed
risk
indicators
One of the most widely respected private institutions that rates the anywhere, particularly by
credit quality of financial institutions is Thomsons BankWatch, Inc. large depositors and those
Thomsons rates both short-term debt and long-term obliga-tions who purchase the stock and
(debt and preferred stock), assessing the likelihood that the capital notes of financial
institutions issuing these obligations may not be able to pay.
firms.
Examples of Thomsons

Long-Term
Ratings

Short-Term Ratings
TBW-1: Very high likelihood of timely
repayment of principal and interest.
TBW-2: Strong likelihood of timely
repayment of principal and interest.
TBW-3: Adequate capacity to
service principal and interest in
a timely way.
TBW-4: Noninvestment grade and
speculative in nature.

Note: The long-term credit ratings

capacity
repay.

to

27:

Strong
ability to repay.

1:

Relatively
strong ability to
repay.

54: Lowest
may be marked
with a + or a

banks,
where
If you wanted to
possible,
compare the overall
should
profitability of the
be
insurance industry to
that of the banking
compare
industry, where would d against
you look? The data
that
of
supplied by the
other
American Council of
national
Life Insurance at
www.acli.org and by banks,
the Insurance
and
Information Institute at
statewww.iii.org would be
chartered
helpful.
institution
s should
be
compare
d against
other
statelicensed
institution
s. If a
financial
firm is an
Key URLs

53: Extremely high

investment
grade2:
Hi
rating
with
an
gher degree
acceptable capacity
of
to repay.
uncertainty
28:
Likeliho and greater
od of default just likelihood of
above investment default than
highergrade with some for
rated issues
significant
uncertainties
affecting
the
capacity to repay.

depending upon rated


whether the
institution

affiliate oforang
a holdinges
company,beca
it can beuse
revealing of
to
their
compare obvio
its
per-us
formance differ
with
ence
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s; the
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than withfinan
independ cialently
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institution field.
s. ThereNo
is an oldtwo
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about
cial
avoiding firms
comparin are
g applesever
and
exact

BankWatch ratings of credit


worthi-ness include these:

29:

Subordi
nated to CCC
obligations with
less
risk
protection.

D: Defaulted
obligation.

55: High
likelihood
of default.
appears to top or nearer the bottom of each
lie nearer therating category.

ly
institutions
alike then proceed
in
caution.
size,
locatio U
n,
s
servic
i
e
menu, n
or
g
custo
mer
base. F
The i
perforn
mance
analys a
t mustn
make
c
his or
i
her
best a
effort
l
to find
the
most R
compaa
rable

andt
with

o
l

t
h

r
T
A

y
t

a
n
k
P

liabilities,
capital,
revenues
,
and
expenses
.

Supple
mentary
items
in
r
the UBPR
f
include
o
breakdow
ns of loan
r
and lease
m
commitme
a
nts,
analysis of
n
problem
c
loans and
e
loan

losses,
and
a
T
profile of
h
each
e
banks
exposure
to risk and
U
its sources
B
of capital.
Bankers
P
can also
R
obtain
Compared to otherpeer
financial institutions,group
more information isreports,
available
aboutwhich
banks than any otherallow them
type of financial firm.
to
comThrough
the
pare their
cooperative effort of
bank with
four federal banking
other
agenciesthe
institutions
Federal
Reserve
of
System, the Federal
comparabl
Deposit
Insurance
e
size;
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the
average
Office
of
Thrift
Supervision, and thereports,
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thewhich
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form
Bankvalues for
Performance Reporteach peer
(UBPR) provides keygroup; and
information
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financial
analysts.reports,
The UBPR, which iswhich
sent quarterly to allpermit
federally supervisedcompariso
banks, reports eachns
banks
assets,between

an
individual
bank and
the
combined
financial
statement
s of all
banks in a
given
state. An
important
added
feature is
that
a
banker
can
acquire
the UBPR
report for
any

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TABLE 65 The Assets Section from the Balance Sheet for National City Bank
Source: Uniform Bank Performance Reports (www.ffiec.gov).

Items (dollar amounts in thousands)


Assets
1. Real estate loans
2. Commercial loans
3. Individual loans
4. Agricultural loans
5. Other loans and leases in domestic offices
6. Loans and leases in foreign offices
7. Gross loans and leases
8. Less: Unearned Income
9. Less: Loan and lease loss allowance
10. Net loans and leases
11. U.S. Treasury and agency securities
12. Municipal securities
13. Foreign debt securities
14. All other securities
15. Interest-bearing bank balances
16. Federal funds sold and resale agreements
17. Trading account assets
18. Total investments
19. Total earning assets
20. Noninterest-bearing cash and deposits due from
other banks
21. Premises, fixed assets, capital leases
22. Other real estate owned
23. Investments in unconsolidated subsidiaries
24. Acceptances and Other assets
25. Total assets
Memoranda:
26. Noninvestment other real estate owned
27. Loans held for sale
28. Held-to-maturity securities
29. Available-for-sale securities

12/31/2004

12/31/2003

$ Change

Percentage
Change

$24,625,884
9,271,907
7,851,544
25,317
212,112
272,417
42,259,181
27,130
514,318
41,717,733
1,087,363
86,420
85
984,143
2,811,741
1,103,067
193,987
6,266,806
47,984,539

$21,209,496
8,672,817
7,912,526
6,369
276,387
234,689
38,312,284
25,738
592,394
37,694,152
1,324,272
20,293
78
1,232,536
12,372
463,760
210,932
3,264,243
40,958,395

$3,416,388
599,090
60,982
18,948
64,275
37,728
3,946,897
1,392
78,076
4,023,581
236,909
66,127
7
248,393
2,799,369
639,307
16,945
3,002,563
7,026,144

16.11%
6.91
0.77
297.50
23.26
16.08
10.30
5.41
13.18
10.67
17.89
325.86
8.97
20.15
22626.65
137.85
8.03
91.98
17.15

1,792,763
558,058
5,643
0
2,633,913
$52,974,916

1,646,705
511,519
6,902
0
3,152,501
$46,276,022

146,058
46,539
1,259
0
518,588
$6,698,894

8.87
9.10
18.24

5,643
23,731
0
2,158,011

6,902
749,899
0
2,577,179

1,259
726,168
0
419,168

18.24
96.84

16.45
14.48%

16.26

other federally supervised bank, thus enabling comparison of banks in the same
market area subject to the same environmental conditions.
To get a better picture of the type of information in the UBPR, we present an example based
on the 2004 and 2003 UBPRs of the lead bank for National City Corporation, National City Bank
(NCB). In Chapter 5, we examined the aggregate numbers for all the banks in this holding
company, using data found at the FDICs Web site. The financial statements we see in this
analysis, however, are focused on a single bank. The format of the UBPR is more detailed and
extensive, but similar to the financial statements presented in Chapter 5.
NCB is a large national bank located in Cleveland, Ohio, with total assets exceeding $52
billion on December 31, 2004. How well or how poorly has NCB performed in recent years? We
will examine this banks financials for 2003 and 2004 in order to provide insights regarding this
question. To put this analysis in context, we should recall that the U.S. cen-tral bank, the
Federal Reserve System, reduced short-term interest rates 13 times from 2001 to 2003 as they
tried to stimulate a sluggish economy. The 10-year Treasury bond yield dropped to a 45-year
low in June of 2003. The lowered interest rates and disappointing stock returns inspired
consumers to invest in real estate, which increased the prices of homes and other properties
while increasing the demand for real estate loans. As the econ-omy slowly recovered from the

business recession of 2001, the Federal Reserve began to


RoseHudgins: Bank
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6. Measuring and
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Their Principal
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Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 187

slowly increase interest rates in 2004. In a period characterized by low, but volatile interest
rates, investors and lenders talked about whether a real estate bubble was about to burst!
Tables 65 through 69, taken from UBPR reports for 2004 and 2003, are used to
assess the performance of NCB. Tables 65 and 66 indicate the principal assets,
liabilities, and capital items held by this bank and show how these items and their
components have increased or decreased in volume since the same time a year earlier. In
terms of growth, NCBs assets increased by more than $6.6 billion for an annual growth
rate close to 14.5 percent (Table 65, line 25). If we examine the asset items having the
largest dollar increases, we find that net loans and leases (item 10) increased by $4.02
billion (10.67 per-cent) and total investments (item 18) increased by $3 billion (91.98
percent). The sources of funds supporting this growth included a $3.21 billion rise (13.01
percent) in total deposits (Table 66, item 9) and a dramatic $4.88 billion increase (169.73
percent) in other borrowings with maturities greater than one year (item 14).

Table 65 indicates that NCB focuses on traditional banking services with $41.7
bil-lion in net loans and leases (item 10). In 2004 NCB increased its real estate loans
(item 1) by 16.11 percent or $3.4 billion, while the balances in most other loan
categories (items 25) increased or decreased by smaller dollar amounts. Essentially,
NCB provided what customers wantedfinancing for housing at a time when prices
in the stock market were declining and securities (i.e., government and private bonds)
were offering histori-cally low returns. The increased proportion of real estate loans
would most likely increase the average maturity of the banks loan portfolio and also
increase its interest-rate risk exposure, a concept introduced earlier in this chapter
and discussed in detail in Part Three of this book.
NCBs deposit growth and its growth in nondeposit liabilities more than covered the
growth in its loan portfolio. In Table 66 we see that deposits in foreign offices (item 8)
increased significantly, up more than 53 percent, while core deposits (item 6) increased a
mere 2.87 percent. Core deposits are the sum of items 15 in Table 66, representing stable funds that are less likely to be removed from the bank. Core deposits also tend to be

TABLE 66 The Liabilities and Capital Section from the Balance Sheet for National City Bank
Source: Uniform Bank Performance Reports (www.ffiec.gov).

Items (dollar amounts in thousands)

12/31/2004

12/31/2003

Liabilities and Capital


1. Demand deposits
2. All NOW and ATS accounts
3. Money market deposit accounts
4. Other savings deposits
5. Time deposits under $100,000
6. Core deposits
7. Time deposits of $100,000 or more
8. Deposits in foreign offices
9. Total deposits
10. Federal funds purchased and REPOs
11. FHL borrowing with maturities less than 1 year
12. FHL borrowing with maturities greater than 1 year
13. Other borrowings with maturities less than 1 year
14. Other borrowings with maturities greater than 1 year
15. Acceptances and other liabilities
16. Total liabilities (including mortgages)
17. Subordinated notes and debentures
18. All common and preferred capital

$3,873,889
270,253
9,087,746
4,611,592
2,797,895
20,641,375
1,934,527
5,343,291
27,919,193
2,820,675
245,006
1,281,709
6,274,512
7,761,259
1,475,244
47,777,598
1,413,606
3,783,712

$4,348,224
189,433
8,219,768
4,652,219
2,655,344
20,064,988
1,149,764
3,490,673
24,705,425
4,139,388
22
1,122,701
6,888,395
2,881,257
2,201,346
41,938,534
1,434,585
2,902,903

$ Change
$474,335
80,820
867,978
40,627
142,551
576,387
784,763
1,852,618
3,213,768
1,318,713
244,984
159,008
613,883
4,880,002
726,102
5,839,064
20,979
880,809

Percentage
Change
10.91%
42.66
10.56
0.87
5.37
2.87
68.25
53.07
13.01
31.86
1113563.64
14.16
8.91
169.37
32.98
13.92
1.46
30.34

19. Total liabilities and capital


RoseHudgins: Bank
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188

52,974,916
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6. Measuring and
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6,698,894

14.48
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among the least expensive sources of funds. Overall, total deposits (item 9) increased by
13.01 percent or $3.2 billion. As interest rates began to rise, NCB increased its borrowings
with maturities greater than one year (item 14) which soared upward by nearly $5 billion.
As market interest rates increased the growth in core deposits subsided and NCB apparently worked to lock in longer-term nondeposit borrowings.
NCB reported substantial growth in security investments, driven by a sharp advance
(137.85 percent) in Federal funds sold and resale agreements (Table 65, item 16) and a
very large gain in interest-bearing bank balances (item 15). NCB apparently increased the
liquidity of its investment portfolio by changing its composition while nearly doubling the
overall size of that portfolio. Liquidity choices on the asset side of the balance sheet
teamed up with increases in long-term nondeposit borrowings as sources of bank funds to
help this large banking firm get ready for rising market interest rates.
Table 67 shows the composition of assets and liabilities held by NCB, using averages
across the four quarters of the year, and presents analogous information for a peer group
of banks. The peer group used for NCB consists of all national banks with average assets
in excess of $3 billion, including the largest 170 banks in 2004 and biggest 163 banks in
2003. The changes in assets and liabilities that we discussed in Tables 65 and 66 are
based on year-end numbers whereas the percentages in Table 67 represent averages
that tend to reduce the effects of seasonality and window dressing. From this point on, our
dis-cussion will focus on average data for NCB and its peers.
For NCB we see relatively small changes in asset composition in Table 67. Net loans
and leases as a percentage of average assets (line 4) increased from 78.41 percent at the
end of 2003 to 81.34 percent as 2004 endeda 3.74 percent increase in net loans and
leases relative to average assets. However, in both years larger percentages of assets
were accounted for by loans at NCB than was true for its peer group who reported ratios
of net loans and leases to average assets of only 58.47 percent in 2003 and 58.91 percent
in 2004. Because loans often represent the highest-yielding assets a bank can hold,
NCBs higher loan-asset ratio would be expected to produce relatively higher earnings
than the average earnings for the peer group.
NCB has slightly decreased its holdings of liquid assets (short-term securities and cash
assets). If we sum the percentages for items 5, 6, 7, 9, and 11 in Table 67, we find that
interest-bearing liquid assets and cash assets accounted for 13.25 percent of assets in
2003 and 11.61 percent of assets in 2004. In contrast, the peer group has about twice the
por-tion of liquid assets relative to total assets. In 2003 and 2004, liquid assets accounted
for 28.11 percent and 27.17 percent of assets at peer institutions. Could NCBs
management be accepting greater liquidity risk (i.e., the possibility of a cash-out) than is
warranted? Banks, like other firms, want to have enough liquid assets to meet their needs
without oppressing profitability with excessive funds invested in relatively low-yielding
instru-ments. Their needs for funds are usually derived from their customers needs for
funds where the customer draws down loan commitments (off-balance-sheet items that
become on-balance-sheet assets) or withdraws deposits.
On the sources of funds side, we note from Table 67 that NCB holds a significantly
smaller proportion of core deposits (item 22) than the peer group of banks. Core deposits,
as reported in the UBPR, include demand deposits, negotiable order of withdrawal (NOW)
accounts, regular savings deposits, money market deposits, and time deposits of less
than $100,000. The difference is derived for the most part from money market deposit
accounts (MMDAs) (in item 19). The cost of MMDAs is comparable to the cost of many
nondeposit sources of funds. Given that their checkable deposits are comparableNCB
has 8.48 percent (sum of items 17 and 18) and the peer group reports 8.56 percentthe

lower proportion of core deposits does not necessarily indicate excessive funding costs.
RoseHudgins: Bank
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Services, Seventh Edition

II. Financial Statements


and Financial Firm
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6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

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Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 189

TABLE 67 Percentage Composition of Assets and Liabilities for National City Bank and Its
Peer Group (all figures are percentages of average total assets)
Source: Uniform Bank Performance Reports (www.ffiec.gov).

Assets: Percentage of average assets


1. Total loans
2. Lease financing receivables
3. Less: Loan and lease loss allowance
4. Net loans and leases
5. Interest-bearing bank balances
6. Federal funds sold and resale agreements
7. Trading account assets
8. Held-to-maturity securities
9. Available-for-sale securities
10. Total earning assets
11. Noninterest-bearing cash and deposits due from other banks
12. Premises, fixed assets, capital leases
13. Other real estate owned
14. Acceptances and other assets
15. Subtotal
16. Total assets
Liabilities
17. Demand deposits
18. All NOW and ATS accounts
19. Money market deposit accounts
20. Other savings deposits
21. Time deposits under $100,000
22. Core deposits
23. Time deposits of $100,000 or more
24. Deposits in foreign offices
25. Total deposits
26. Federal funds purchased and REPOs
27. Total federal home loan borrowings
28. Total other borrowings
29. Memo:Short-term noncore funding
30. Acceptances and other liabilities
31. Total liabilities (including mortgages)
32. Subordinated notes and debentures
33. All common and preferred capital
34. Total liabilities and capital

NCB
12/31/04

Peer
12/31/04

NCB
12/31/03

Peer
12/31/03

82.50%
0.01
1.17
81.34
1.18
1.85
0.53
0.00
4.62
89.52
3.43
1.06
0.01
5.98
10.48
100.00

58.22%
1.03
0.80
58.91
0.76
2.37
0.34
2.01
21.02
90.08
2.68
1.09
0.05
5.82
9.92
100.00

79.65%
0.02
1.26
78.41
0.03
2.19
0.63
0.00*
6.55
87.81
3.85
1.03
0.02
7.29
12.19
100.00

57.68%
1.19
0.86
58.47
0.87
2.61
0.39
1.45
21.11
89.84
3.13
1.08
0.05
5.49
10.16
100.00

8.05
0.43
17.91
9.38
5.30
41.07
2.80
9.86
53.73
8.12
2.62
21.97
22.47
4.03
90.46
2.90
6.64
99.99

6.65
1.91
24.34
8.42
8.36
54.67
8.99
1.94
68.35
8.00
4.63
2.64
22.84
2.10
89.83
0.62
9.39
100.00

9.28
0.42
19.34
9.83
6.40
45.27
3.95
4.75
53.97
10.83
2.34
17.77
26.39
5.46
90.36
3.14
6.50
99.99

6.59
1.81
22.00
8.73
9.59
53.93
9.02
2.04
67.82
8.16
4.81
2.84
22.85
2.46
90.24
0.71
8.93
100.00

* Figure is less than 0.05 percent.

When we look at nondeposit liabilities, we see that total other borrowings are
significantly higher for NCB than for the peer group. To some extent, NCB has
substituted nondeposit borrowings for money market deposits compared to its peers.
Turning to NCBs statement of earnings and expenses (Table 68), we must recall the
changing interest rate environment from the beginning of 2003 to the conclusion of 2004.
Interest rates hit bottom in 2003 and then began to rise slowly. The federal funds rate
dropped below 1 percent in December 2003 and then climbed to 2.28 percent by year-end
2004. The 30-year home mortgage interest rate dropped to a low of 5.23 percent in June
2003, rose to a high of 6.29 percent in June 2004, and ended that year at 5.71 percent.
While total interest income (item 16) increased by 11.56 percenta favorable resulttotal
interest expenses also increased. In an ideal world we would like income to

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190 Part Two Financial Statements and Financial Firm Performance

TABLE 68 National City Bank Income Statement (Revenues and Expenses)


Source: Uniform Bank Performance Reports (www.ffiec.gov).

Items (dollar amounts in thousands)

12/31/2004

12/31/2003

Percentage Change

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.

$2,170,542
102
2,071
976
2,171,620
2,333
73,379
13
35,919
27
111,644
4,968
19,225
5,393
4,310
2,317,160
88,743
36,021
156,541
61,140
208,472
0
34,627
585,544
1,731,616
802,999
2,534,615
1,243,716
147,147
1,143,752
0
5,992
1,149,744
421,806
989
0
422,795
726,949
0
726,949
150,000
576,949

$1,927,084
86
1,998
909
1,928,079
7,812
69,222
11
50,196
25
127,241
493
15,239
1,688
4,351
2,077,091
33,449
43,248
188,654
64,926
162,851
0
25,019
518,147
1,558,944
783,373
2,342,317
1,160,735
422,562
759,020
0
3,639
762,659
208,817
920
0
209,737
552,922
0
552,922
300,000
252,922

12.63%
18.60
3.65
7.37
12.63
70.14
6.01
18.18
28.44
8.00
12.26
907.71
26.16
219.49
0.94
11.56
165.31
16.71
17.02
5.83
28.01
0.00
38.40
13.01
11.08
2.51
8.21
7.15
65.18
50.69
0.00
64.66
50.75
102.00
7.50
0.00
101.58
31.47
0.00
31.47
50.00
128.11

Interest and fees on loans


Income from lease financing
Tax-exempt
Estimated tax benefit
Income on loans and leases (tax-equivalent basis)
Income from U.S. Treasury and agency securities
Mortgage-backed securities (MBS) income
Estimated tax benefit
Income from all other securities
Tax-exempt securities income
Investment income (tax-equivalent basis)
Interest on due from other banks
Interest on federal funds sold and resales
Trading account income
Other interest income
Total interest income (tax-equivalent basis)
Interest on deposits in foreign offices
Interest on time deposits over $100,000
Interest on all other deposits
Interest on federal funds purchased & repurchase agreements
Interest on trading liabilities and other borrowings
Interest on mortgages and leases for other property & equipment
Interest on subordinated notes and debentures
Total interest expense
Net interest income (tax-equivalent basis)
Noninterest income
Adjusted operating income (tax-equivalent basis)
Noninterest expense
Provision: Loan and lease losses
Pretax operating income (tax-equivalent basis)
Realized gains/losses on held-to-maturity securities
Realized gains/losses on available-for-sale securities
Pretax net operating income (tax-equivalent basis)
Applicable income taxes
Current tax equivalent adjustments
Other tax-equivalent adjustments
Applicable income taxes (tax-equivalent basis)
Net operating income
Net extraordinary items
Net income
Cash dividends declared
Retained earnings (addition to)

go up and expenses to go down. This ideal situation is similar to the famous directive to
investors to Buy Low and Sell Highsimplistic in theory but hard to apply, especially
when we are talking about interest income and expenses and both items are correlated
with market interest rates. (We will soon be exploring the effects of these correlations in
Chapter 7.) Most interest income items (items 1 through 15 in Table 68) increased and,
while the signs were mixed for individual interest expense items (items 1723), the overall effect was an increase in NCBs total interest expenses (item 24).
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Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 191

Factoid
Beginning in 1997 federal law allowed banks and other corporate
financial institutions that qualify to become Subchapter S
corporations, which are

NCB
s
net
interest
income
(item
25)
increase
d
by
11.08
percent
during
the year.
When
net
interest
income
is
measure
d
relative
to
average
total
assets,
the net
interest
margin
(NIM)
increase
s slightly
as
illustrate
d by the
following
:

Interest income
from loans andInterest expense on
security investments
treated like partnerships for federal tax
purposes.

Avera
ge
assets

borrowed funds
Net interest margin

TABLE 69
Relative Income
Statement and Margin
Analysis for National
City Bank and Its Peer
Group (all figures are
percentages of average
total assets)
Source: Uniform Bank
Performance Reports

(www.ffiec.gov).

NCB
2004
1. Total interest income (tax-equivalent basis)
2. Less: Interest expense
3. Equals: Net interest income (tax-equivalent basis)
4. Plus: Noninterest income
5. Minus: Noninterest expense
6. Minus: Provision for loan and lease losses
7. Equals: Pretax operating income
(tax-equivalent basis)
8. Plus: realized gains/losses on securities
9. Equals: Pretax net operating income
(tax-equivalent basis)
10. Net operating income
11. Adjusted net operating income
12. Net income adjusted for Subchapter S status
13. Net income

The numbers in the


numerator are taken from
Table 68, items 16 and
24. The denominator is
average assets based on
quarterly totals for 2004 of
$48,025,306 thousand
and for 2003 of
$44,445,794 thousand.
5

The numerator is based on


item 38 in Table 68 and the
denominator is average
assets as provided in
footnote 4.

Peer Group NCB


2004
2003

Peer Group
2003

4.82%
1.22
3.61
1.67
2.59
0.31

4.46%
1.20
3.23
1.73
2.89
0.14

4.67%
1.17
3.51
1.76
2.61
0.95

4.57%
1.29
3.23
1.83
2.95
0.27

2.38
0.01

1.97
0.02

1.71
0.01

1.89
0.05

2.39
1.51
1.43

2.00
1.31
1.29
1.31
1.31

1.72
1.24
1.37

1.95
1.28
1.29
1.28
1.28

1.51

1.24

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increased significantly: while NCBs net operating margin rose by a whopping


21.77 per-cent, the peer groups comparable ratio increased by only 2.34
percent. By this measure NCB outshines its peer group of banking firms.
However, NCBs stockholders will probably be most concerned about the earnings
per share (EPS) of stock that they hold. National City Corporation (the bank holding
com-pany) had 605,996,120 shares outstanding in 2003 and 646,749,650 shares of
stock in 2004 (according to its annual report submitted to the SEC and accessible
using the student version of S&Ps Market Insights and the associated Edgar link).
Using this data we can calculate the EPS on a bank basis (using net income from
NCB). Its EPS changed as fol-lows between year-end 2003 and 2004:

EPS

Net income
Common equity shares outstanding
2004
$726,949,000
646,749,650 $1.12 per share

2003
$552,922,000
605,996,120 $0.91 pe

The bank experienced a significant jump in stockholders earnings per share.


Remem-ber this calculation is based on the net income for the lead bank divided
by the number of shares of National City Corporation, the bank holding company.
Hence, caution in inter-preting these results is important. Keeping this in mind,
management would certainly like to see this trend continue.
As we move further down the income and expense statement in Table 68 we see
that, while net interest income increased by 11.08 percent in 2004, net income (item
40) increased by a remarkable 31.47 percent! This was due to a small 2.51 percent
increase in noninterest income (item 26), a 64.66 percent increase in realized gains
on available-for-sale securities (item 32), and a 65.18 percent decrease in the
provision for loan and lease losses (item 29). With a bank that focuses substantially
on lending like NCB, changes in the Report of Incomes provision for loan and lease
losses (item 29) and the related loan and lease allowance for losses account (item 9
in Table 65) contained in the Report of Condition may provide some insights into the
quality of the banks loan portfolio. (Note: If you are a bit confused about what these
accounts represent, please review the discussion in Chapter 5.)
NCBs loan-loss provision expense of $147,147 thousand was just over a third of the loss
provision for the previous year. The loan-loss allowance account decreased 13.18 per-cent to
$514,318 thousand. This tells us that the annual loan-loss expense was less than the actual
volume of net charge-offs, resulting in a smaller allowance account on NCBs Report of
Condition. According to Table 67 the loan and lease loss allowance to average assets (item 3)
went from 1.26 percent in 2003 to 1.17 percent in 2004. Management appears to be cashing in
on the low loan losses that were characteristic of this time period.

How did NCB do relative to its peer group with regard to income and expenses?
Table 69 provides a glimpse of an answer for this question. NCB improved its
performance in 2004. It outperformed its peer group on interest income (item 1) and
noninterest expense (item 5) in both 2003 and 2004. Outperformed means NCBs
interest income was higher as a percentage of its average assets and its noninterest
expenses were lower as a percent-age of its average assets than comparable banks.
The lower noninterest expense indicates that management has succeeded in
controlling overhead costs relative to its peer group. Overall, the successes regarding
interest income and noninterest expenses illustrated in the upper portion of Table 69
led to both higher net operating income (item 10) and higher net income (item 13)

relative to average total assets for NCB versus its peer group of banks in 2004.
RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 193

NCB looks good relative to its peers and the profitability ratios are getting
better. ROA increased by 21.77 percent. We can explore NCBs earnings further
using Equa-tions (611), (614), and (618) discussed earlier in this chapter.
Equation (611) pro-vides the following breakdown using quarterly average
figures for Report of Condition items:
ROE

Average
assets

ROA
Average
equity capital

NCBs ROE in 2004:

ROE
0
.
0
1
5
1

1
5
.
0
6
0
.
2
2
8
0
o
r
2
2
.
8
0
%

NCBs ROE in 2003:

ROE
0
.

Cle
arly,
NCB
s
ROE
increa
sed
becau
se its
ROA
a
meas
ure of
mana
gerial
efficie
ncy
impro
ved.
At the
same
time
NCB
s use
of
levera
ge
(i.e.,
the
propo
rtion
of its
asset
s supporte
d by
debt)
decre
ased.
Mana

gem red in 2004 was half the 2003 dividend


ent declaration and this tended to lower the
and equity multiplier.
the
We can expand this analysis a bit
boar
further using Equation (614) for
d of ROE:
direc
tors
expa
nded
the
amo
unt
of
equit
y
capit
al
throu
gh
incre
ased
profit
s
and
redu
ction
s in
stock
divid
end
pay
ment
s.
The
dolla
r
amo
unt
of
divid
ends
decla

Net income

ROE

Total operating revenue

Total operating revenue


Average
equity capital

NCBs ROE in 2004:

ROE

$
726,949
$ 3,120,159
$
3,120,159 $
$ 48,025,306
48,025,306
$
3,188,880

Average assets

Avera
ge
assets
.80%we ROA is item 13 from Table 69
and for balance sheet items
re:
we use average assets as
NC
(1) reported in the UBPR and
Bs
NC derive average equity capital
RO
from item 33 in Table 67. For
Bs 2004 average equity capital
E
in
risi equaled 6.64 percent of
average assets where
20
ng average assets were
03.
net $48,025,306.
7

7
pro Total operating revenue is item

ROEfit

ma

$
2,860,464
$
44,445,794
$ 44,445,794
$

rgi
n,

whi

ch

0.1933

inc

se
19.14%
W

hat

fact
ors
in

the

se
ear
nin

1
5

gs
rela
tion

ship

cau
sed
NC

Bs
retu

rn

to

stoc

8
0

its
khol
der
s
(RO

E)

rise

to
?

2
2

0.0644

15.38rea 0.1914 or

16 plus item 26 from Table 68.

The
key
fact
ors

d
by
20.
54
per
ce
nt,
an
d
(2)
the
ne
arl
y 1
per
ce
nt
ris
e
in
NC
Bs
as
set
utili
zat
ion
rati
o
(op
era
tin
g
6

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

194

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Perfromance

revenues to average assets). These positive effects were mitigated to some extent by
the 2.08 percent decline in the equity multiplier from 15.38 times to 15.06 times.

Analysis of ROE using Equation (618) emphasizes NCBs record of expense


control as illustrated by its rising net profit margin and improved asset
management efficiency. The relevant equation is:
Net income
Pretax net operating income

ROE

Total operating revenues


Average assets
NCBs ROE in 2004:
ROE

Pretax net operating incom


Total operating revenues
Average assets
Average equity capital

$
726,949
$ 1,149,744

0.6323

$ 1,149,744
$
3,120,159

0.3685

$
3,120,159
$ 48,025,306

0.0650

$ 48,025,306
$
3,188,880

15.06

0.2280 or 22.80%
NCBs ROE in 2003:
ROE

$ 552,922
$
762,659

0.7250

$
762,659
$ 2,860,464

0.2666

$
2,860,464
$ 44,445,794

0.0644

$ 44,445,794
$
2,888,977

15.38

0.1914 or 19.14%
A glance at the breakdown of ROE above shows a decline in tax-management efficiency
with net income to pretax operating income decreasing from 72.50 percent in 2003 to 63.23
percent in 2004. For every dollar of pretax operating income NCB paid out about 27 cents in
taxes in 2003, which rose further to nearly 37 cents in 2004. On a brighter note, however, the
measure of expense-control efficiency (pretax net operating income to total operating revenue)
advanced by more than 38 percent, pointing to improved expense control.

In conclusion, we have utilized the tools developed in this chapter and NCBs UBPR to
get a better picture of the operations and management of this bank. NCB appears to be
more focused on the traditional business of lending than is the average large bank today.
Its operations have generated higher revenues and lower expenses than its peers and this
performance superiority generally broadened between 2003 and 2004.
8

Pretax net operating income is item 33 from Table 68.

www.mhhe.com/rose7e

S
u
m
m
a
r
y

The principal focus of this chapter has


been on how well banks and other
financial firms perform in serving their
customers and in providing acceptable
returns to their owners. We have also
noted that many of the measures of
financial-firm performance provide key
insights regarding the interindustry

competition today between banks, thrift institutions,


security brokers and dealers, mutual funds, finance
companies, and insurance firms. Increasingly,
bankers and their competitors are being forced to
assess their performance over time, analyze the
reasons for any performance problems that appear,
and find ways to strengthen their performance in the
future.

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 195

Among the key points made in the chapter are these:

1 The two key dimensions of performance among financial-service firms are


profitability and risk. Satisfactory profits and adequate risk controls preserve
capital, providing a basis for a financial firms survival and future growth.

2 For

the largest profit-oriented financial institutions the market value of their stock
(equities) is usually the best overall indicator of profitability and risk exposure.

3 For smaller financial firms whose stock is not actively traded every day a
number of key profitability ratios (such as return on assets, return on equity
capital, net interest margin, noninterest margin, and earnings spread) become
important performance measures and significant managerial targets.

4 Pursuit

of profitability must always be tempered with concern for risk exposure,


includ-ing the management and control of credit or default risk, liquidity or cash-out
risk, mar-ket risk to the value of assets and liabilities held, interest-rate risk,
operational risk, legal and compliance risks, reputation risk, strategic risk, and
capital risk. The latter risk measure focuses upon the probability of ultimate failure
if a financial firm is undercap-italized relative to the risks it faces.

5 Increasingly financial-service firms are adding operating efficiency to their list


of perfor-mance criteria, focusing upon measures of expense control and the
productivity of employees in managing assets, revenues, and income.

6 The chapter concludes with a discussion of the Uniform Bank Performance Report
(UBPR) available from the Federal Financial Institutions Examination Council. This
financial report on individual FDIC-insured commercial and savings banks has
become one of the most widely used performance summaries available to
bankers, regulators, customers, and the general public.

www.mhhe.

Key Terms

net
prof
it
mar
gin,
170
ass
et
utili
zati
on,
170
equ
ity
mul
tipli
er,
170
cre
dit
risk,
177
liqui
dity
risk,
178
mar
ket
risk,
178
inte
rest
rate
risk,
179

operati
onal
risk,
179
legal
risk,
180
compli
ance
risk,
180
reputat
ion
risk,
180
strateg
ic risk,
180
capital
risk,
180
UBPR,
185

com/rose7e

1.r

Problems
and Projects

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RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

196

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Part Two Financial Statements and Financial Firm Perfromance

What is the value of the equity multiplier for each of these institutions?
Suppose that both institutions have an ROA of 0.85 percent. What must
each institutions return on equity capital be? What do your calculations tell
you about the benefits of having as lit-tle equity capital as regulations or the
marketplace will allow?

4. The latest report of condition and income and expense statement for
Galloping Mer-chants National Bank are as shown in the following
tables:
Galloping Merchants National Bank
Income and Expense Statement (Report of Income)

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Interest and fees on loans


Interest and dividends on securities
Total interest income
Interest paid on deposits
Interest paid on nondeposit borrowings
Total interest expense
Net interest income
Provision for loan losses
Noninterest income and fees
Noninterest expenses:
Salaries and employee benefits
Overhead expenses
Other noninterest expenses
Total noninterest expenses
Pretax operating income
Securities gains (or losses)
Pretax net operating income
Taxes
Net operating income
Net extraordinary items
Net income
*Note: the bank currently has 40 FTE employees.

Galloping Merchants National Bank


Report of Condition
Assets
Cash and deposits due from banks
Investment securities
Federal funds sold
Net loans
(Allowance for loan losses = 25)
(Unearned income on loans = 5)
Plant and equipment
Total assets

Total earning assets

$100
150
10
670

50
980

830

Liabilities
Demand deposits
Savings deposits
Time deposits
Federal funds purchased
Total liabilities
Equity capital
Common stock
Surplus
Retained earnings
Total capital
Interest-bearing deposits

Fill in the missing items on the income and expense statement. Using
these statements, calculate the following performance measures:
ROE

Asset utilization

ROA
Net interest margin
efficiency

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 197

Net noninterest margin Expense control efficiency


Net operating margin Asset management efficiency
Earnings spread

Funds management efficiency

Net profit margin

Operating efficiency ratio

What strengths and weaknesses are you able to detect in Galloping


Merchants perfor-mance?
5. The following information is for Shallow National Bank:

Interest income
Interest expense
Total assets
Security losses or gains
Earning assets
Total liabilities
Taxes paid
Shares of comon stock outstanding
Noninterest income
Noninterest expense
Provision for loan losses

2
2

Please calculate:
ROE
ROA
Net interest margin
Earnings per share
Net noninterest margin
Net operating margin
Alternative scenarios:

_____
_____
_____
_____
_____
_____

1. Suppose interest income, interest expenses, noninterest income, and


noninterest expenses each increase by 5 percent while all other revenue
and expense items shown in the preceding table remain unchanged. What
will happen to Shallows ROE, ROA, and earnings per share?

2. On the other hand, suppose Shallows interest income and expenses as well as its
noninterest income and expenses decline by 5 percent, again with all other factors
held constant. How would the banks ROE, ROA, and per-share earnings change?

6. Blue and White National Bank holds total assets of $1.69 billion and equity capital of
$139 million and has just posted an ROA of 1.10 percent. What is the banks ROE?

Alternative scenarios:

1. Suppose Blue and White Bank finds its ROA climbing by 50 percent, with
assets and equity capital unchanged. What will happen to its ROE? Why?

2. On the other hand, suppose the banks ROA drops by 50 percent. If total assets
and equity capital hold their present positions, what change will occur in ROE?

3. If ROA at Blue and White National remains fixed at 0.0076 but both total
assets and equity double, how does ROE change? Why?

4. How would a decline in total assets and equity by half (with ROA still at
0.0076) affect the banks ROE?

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remain fixed?

2. Suppose Monarch States total assets and total liabilities increase by


10 percent, but its revenues and expenses (including taxes) are
unchanged. How will the banks ROE change?

3. Can you determine what will happen to ROE if both operating


198 Pa
rt
T
w
o
Fi
na
nc
ial
St
at
e
m
en
ts
an
d
Fi
na
nc
ial
Fi
r
m
P
er
fr
o
m
an
ce

7.

revenues and expenses (including taxes) decline by 10 percent, with


the banks total assets and liabilities held constant?

4. What does ROE become if Monarch States assets and liabilities


decrease by 10 percent, while its operating revenues, taxes, and
operating expenses do not change?

8. Suppose

a stockholder-owned thrift institution is projected to achieve a 1.25


per-cent ROA during the coming year. What must its ratio of total assets to
equity cap-ital be if it is to achieve its target ROE of 12 percent? If ROA
unexpectedly falls to

0.75 percent, what assets-to-capital ratio must it then have to reach a


12 percent ROE?
9. Saylor County National Bank presents us with these figures for the year
just con-cluded. Please determine the net profit margin, equity
multiplier, asset utilization ratio, and ROE.
Net income
Total operating revenues
Total assets
Total equity capital accounts

10. Lochiel Commonwealth Bank and Trust Company has experienced the
following trends over the past five years (all figures in millions of
dollars):

Year

Net Income
After-Tax

Total Operating
Revenues

Total Assets

To

1
2
3
4
5

$2.70
3.50
4.10
4.80
5.70

$26.50
30.10
39.80
47.50
55.90

$293.00
382.00
474.00
508.00
599.00

Determine the figures for ROE, profit margin, asset utilization, and equity
multiplier for this bank. Are any adverse trends evident? Where would you
recommend that management look to deal with the banks emerging
problem(s)?
11. Wilmington Hills State Bank has just submitted its Report of Condition and
Report of Income to its principal supervisory agency. The bank reported net
income before taxes and securities transactions of $27 million and taxes of $6
million. If its total operating

Alternative
scenarios:

1.

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 199

revenues were $780 million, its total assets $2.1 billion, and its equity capital
$125 million, determine the following for Wilmington:

1. Tax management efficiency ratio.


2. Expense control efficiency ratio.
3. Asset management efficiency ratio.
4. Funds management efficiency ratio.
5. ROE.
Alternative scenarios:

1. Suppose Wilmington Hills State Bank experienced a 20 percent rise in net


before-tax income, with its tax obligation, operating revenues, assets, and
equity unchanged. What would happen to ROE and its components?

2. If total assets climb by 20 percent, what will happen to Wilmingtons


efficiency ratio and ROE?

3. What effect would a 20 percent higher level of equity capital have upon
Wilmingtons ROE and its components?

12. Using this information for Lochness International Bank and Trust Company (all figures
in millions), calculate the banks net interest margin, noninterest margin, and ROA.
Interest income
Interest expense
Provision for loan losses
Security gains (or losses)
Noninterest expense
Noninterest income
Extraordinary net gains
Total assets

13. Valley Savings reported these figures (in millions) on its income statement for the past
five years. Calculate the institutions ROA in each year. Are there any adverse trends?
Any favorable trends? What seems to be happening to this institution?

Gross interest income


Interest expenses
Noninterest income
Noninterest expense
Provision for loan losses
Income taxes owed
Net securities gains (losses)
Total assets

Current
Year

One Year
Ago

Two Years
Ago

Three Years
Ago

$40
24
4
8
2
1
2
385

$41
23
4
7
1
1
1
360

$38
20
3
7
1
0
0
331

$35
18
2
6
0
1
1
319

14. An analysis of the UBPR reports on NCB was presented in this chapter. We examined a
wide variety of profitability measures for that bank, including ROA, ROE, net profit mar-gin,
net interest and operating margins, and asset utilization. However, the various mea-sures
of earnings risk, credit risk, liquidity risk, market risk (price risk and interest rate risk), and
capital risk were not discussed in detail. Using the data in Tables 65 through 69,
calculate each of these dimensions of risk for NCB for the most recent two years and

Fou

discuss how the banks risk exposure appears to be changing over time. What steps would
you recommend to management to deal with any risk exposure problems you observe?

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to be growing faster and why. Which would you recommend as a possible takeover target and why?

2. A guest speaker visiting your class contends that Bank of America is one
of the most profitable banks of its size in the United States. Your
instructor says thats really not true; it tends to be a middle-of-the-road
performer. Check these claims out on the Web (for example, at
www.bankofamerica.com and www.fdic.gov). Who is right and what
makes you think so?

20

3. The Uniform Bank Performance Reports (UBPRs) provide detailed

0
Pa
rt
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o
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na
nc
ial
St
at
e
m
en
ts
an
d
Fi
na
nc
ial
Fi
r
m
P
er
fr
o
m
an
ce

financial perfor-mance data on all federally supervised U.S. banks.


Using the Web site of the Federal Financial Institutions Examination
Council (at www.ffiec.gov), see if you can deter-mine what happened to
the earnings and credit risk exposure of Wachovia Corp.
(www.wachovia.com) and Wells Fargo Bank (www.wellsfargo.com) in
the most recent year for which data is available.
S&P Market Insight Challenge (www.mhhe.com/edumarketinsight)

1. You can depend on S&P Industry Surveys concluding with sections on How to Analyze a Company and a Comparative Company Analysis. To access these surveys
use the Industry tab, and the drop-down menu supplies several subfinancial-service
indus-try selections, such as Asset Management & Custody Banks, Consumer
Finance, Diver-sified Banks, Diversified Capital Markets, Insurance Brokers,
Investment Banking and Brokerage, Life & Health Insurance, Multiline Insurance,
Property & Casualty Insur-ance, Regional Banks, and Thrifts & Mortgage Finance.
Once an industry has been selected you will find downloadable S&P Industry
Surveys, covering such key financial-services sectors as Banking, Investment
Services, Financial Services Diversified, Insur-ance: Property and Casualty,
Insurance: Life and Health, and Savings and Loans. Please download S&P Industry
Surveys for two of these financial sectors and review the How to Analyze and
Comparative Company Analysis write-ups on each. In each category of financial
firms found in the Comparative Company Analysis, identify the firm with the highest
return on equity capital (ROE). How do the ROEs compare across categories and
subindustries? Are there any other performance measures that could be compared
across financial-service sectors?

Internet Exercises

2. Today

1.

banks, securities firms, insurance companies, and finance/credit-card

businesses are battling for many of the same customers and for many of the same
sources of capital to sup-port their growth and expansion. As a result there is keen
interest today in the compara-tive financial performance of firms in these four
competing industries. Using S&Ps Market Insight, Educational Version, see if you
can determine which of these financial-service industries are outperforming the
others in terms of returns on equity capital and risk exposure. You may find it useful
to select certain firms from the Market Insight file to com-pare performances across
these industries. For example, you can compare the financial statements of such
companies as MetLife Insurance Inc. (MET), Capital One Financial Group (COF),
Goldman Sachs Group (GS), and FleetBoston Financial Corp. (FBF).

Amsouth

Bank

(www.amsouth.com
BB&T (

SunTrust
Banks
(www.suntrust.com
Using
the
above
company Web sites
and other appropriate
sites, determine which
of these banks seems

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 201

R E AL N U M B E R S
F O R R EAL BAN K S

Assignment for Chapter 6

EVALUATION OF YOUR BANKS PROFITABILITY


Part One: A Performance Comparison to Peers
In Chapter 6 we focus on the evaluation of financial statements. Key
profitability ratios are introduced and ROE and ROA are bro-ken down
into component ratios to aid interpretation. We used the UBPR for
National City Bank, the lead bank of National City Corporation, to
illustrate trends (comparison of December 2004 with December 2003
bank data) and for comparative analysis (comparison of bank data with
peer group data). You will be eval-uating your BHC by (1) calculating
percentage changes using your dollar data and interpreting this

in Column E for each


item.
Write
one
paragraph
discussing
the
percentage changes
in Total Assets, Total
Liabilities, and Total
Equity Capital.

2. The

spreadsheet

containing

items

expressed

as

information; (2) comparing your BHC with the group of peer banks using

percentages

the percentages-to-total assets data; and (3) utilizing the profitability

developed

ratios discussed in this chapter to evaluate managements performance.

Comparisons

1. Open your Excel Workbook and go to the spreadsheet con-taining

Peer Group in Chapter

dollar amounts for Year-to-Year Comparisons. Delete any numbers in

Real Banks assignment

columns D and E. Refer to Tables 65, 66, and 68 as examples for

is very similar to the data

what you are about to do. Calculate the dollar changes in Column D

provided

and the Percentage Changes

Tables 67 and 69.

of

assets
for

with

the

5s Real Numbers for

for

NCB

1. Write

in

one

paragraph
asset

the

in

for your BHC with

that

of

the

peer

2. Write

one

comparing
sources

the

of

funds

composition

for

your BHC with that


of the peer group.

3. Write

For example, the formula for ROE entered in cell B54 would be:
=B52/B26.

3. In rows 54 through 58, calculate the key profitability ratios from


Equations (64) through (68) in the chapter. Write one
paragraph comparing profitability across years.

4. Rows 59 through 62 provide the framework for a break-down of


equity returns using Equations (614) through (617) in this
chapter. Write one paragraph discussing the

us
in

paragraph

Excel and the data in Rows 1 through 52 to cre-ate the entries.

ge

composition

group.

then for the prior year in column C using the formula functions in

ch
an

comparing

2. Calculate the ratios for the most recent year in Column B and

s
p

one

paragraph
comparing
the
components
of
income
and
expenses for your
BHC with that of
the peer group.

g
thi
s
br
ea
kd
o
w
n.
In
co
rp
or
at

Part Two: A
Breakdown of
Returns

1. Open

ba

Year

the Year-toComparisons

th
e
si

c equation and interpret the information for your bank.

5. Rows 63 through 65 call for a breakdown of the net profit


margin, as illustrated by Equation (618). Write one paragraph discussing the components of the net profit margin for
your bank and the implications of the changes occur-ring
across the years.

6. Rows 66 through 69 provide the framework for a breakdown of ROA (Equation [620] in this chapter). Write one
paragraph discussing the change in ROA and its components for your bank.

www.mhhe.com/rose7e
RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

202 Part Two Financial Statements and Financial Firm Perfromance

Selected
References

For an explanation of measuring and evaluating risk in banking and financial services, see the following studies:

1. Gilbert, R. Alton, Andrew P. Meyer, and Mark D. Vaughn. How Healthy Is


the Bank-ing System? Funneling Financial Data into Failure Probability.
Regional Economist, Federal Reserve Bank of St. Louis, April 2001, pp.
1213.

2. Kristad, Jeffrey, and Pat Donnelly. An Examiners View of Operational


Risk. Bank News, July 31, 2001, pp. 2527.

3. Rose, Peter S. RiskTaking the Temperature and Finding a Cure. The


Canadian Banker, November/December, 1987, pp. 5463.

4. Wright,

David M., and James Houpt. An Analysis of Commercial Bank


Exposure to Interest Rate Risk. Federal Reserve Bulletin, February 1996,
pp. 11628.

For information on how to read bank financial statements and make


comparisons among different institutions, see the following:

5. Federal Financial Institutions Examination Council. A Users Guide for


www.mhhe.com/rose7e

the Uniform Bank Performance Report. Washington, D.C., 2002.

6. Gilbert, R. Alton, and Gregory E. Sierra. The Financial Condition of U.S.


Banks: How Different Are Community Banks? Review, Federal Reserve
Bank of St. Louis, Janu-ary/February 2003, pp. 4356.

7. Gunther, Jeffrey W., and Robert R. Moore. Financial Statements and


Reality: Do Trou-bled Banks Tell All? Economic and Financial Review,
Federal Reserve Bank of Dallas, Third Quarter 2000, pp. 3035.

8. Klee, Elizabeth C., and Fabio M. Natalucci. Profits and Balance Sheet Developments
at U.S. Commercial Banks in 2004. Federal Reserve Bulletin, Spring 2005, pp. 143
74.

9. Wetmore,

Jill L., and John R. Brick. The Basis Risk Component of


Commercial Bank Stock Returns. Journal of Economics and Business 50
(1998), pp. 6776.

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

The McGrawHill
Companies, 2008

Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 203

Appendix
Improving the Performance of Financial Firms through Knowledge:
Sources of Information on the Financial-Services Industry
Chapter 6 focused on how to measure the performance of
Insurance
banks and some of their closest competitors in todays Information Institute (III)
financial marketplace. However, mere measurement of the at www.iii.org.
dimensions of performance is not enough. Managers must
In addition to the material
have the tools and the knowledge necessary to improve
provided by these and
performance over time. The chapters that follow this one will
other
trade
provide many of the tools needed for suc-cessful numerous
associations,
dozens
of
management of a financial institution, but man-agers will
journals
and
books
are
always need more information than textbooks can provide.
Their problems and solutions may be highly technical and will released each year by book
houses,
shift over time, often at a faster pace than the one at which publishing
textbooks are written. The same difficulty confronts regulators magazine pub-lishers, and
agencies.
and customers. They must often reach far afield to gather government
vital information in order to evaluate their financial-service Among the most impor-tant
of these recurring sources
providers and get the best service from them.
Where do the managers of financial institutions find the are the following:
information they need? One good source is the professional
schools in many regions of the nation. Among the most popularGeneral
of these is the Stonier Graduate School of Banking sponsored by Information on
the American Bankers Association. Other professional schools Banking and
are often devoted to specific problem areas, such as marketing, Competing
consumer lending, and commercial lending. Each offers Financial-Service
educational materials and often supplies homework problems to Industries
solve.
Beyond the professional schools, selected industry trade 1 ABA Banking Journal
(published by the
associations annually publish a prodigious volume of written
American
Bankers
studies and management guidelines for wrestling with important
Association
at
performance problems, such as developing and promoting new
www.banking.com).
services, working out problem assets, design-ing a financial plan,
and so on. Among the most popular trade associations publishing2 Risk
Management
problem-solving information in the financial-services field are:
and
Lending

1 The American Bankers Association at www.aba.com.


2 Bank Administration Institute at www.bai.org.
3 Risk Management Association (RMA), Association

Professionals Journal
(pub-lished by the
Risk
Management
Association at www.
rmahq.org).

of
Risk Management and Lending Professionals at www.
3 The Canadian Banker
rmahq.org.
(published by the
4 Americas Community Bankers at www.acbankers.org.
Canadian
Bankers
Association
at
5 Credit Union National Association (CUNA) at www. www.cba.ca).
cuna.org.
Bank Marketing
6 American Council of Life Insurance (ACLI) at www.4 ABA
Magazine
at
acli.org.
www.aba.com/Mar7 Investment Company Institute (ICI) at www.ici.org.
ketingNetwork.
Sources
of Data

on
Individual
Banks
and
Competin
g
Financial
Firms

1 Uniform

Bank
Performance Reports
(UBPR)
(published
quarterly by the Federal
Financial
Institutions
Examina-tion Council at
www.fiec.gov).

2 Historical

Bank
Condition and Income
Reports
(avail-able
from
the National
Technical Information
Service
at
www.ntis.org).

3 American

Banker
Online
(banking
industry
newspaper
published
by
the
American
Bankers
Association
at
www.americanbanke
r.com).

4 The

Wall
Street
Journal (published by
Dow Jones & Co.,
Inc., and online at
www.wsj.com).

Economic and
Financial Trends
Affecting Banking
and the Financial
Services Sector

1 Survey

of

Current

Business (published by the


U.S.

Depart-ment

of

Commerce at www.bea.gov/bea/pubs.htm).

2 Federal Reserve Bulletin (published by the Board of Governors of the Federal Reserve System and available at
www.federalreserve.gov/pubs/bulletin).

3 National

Economic
Trends and Monetary
Trends (all pub-lished
by
the
Federal

Reserve Bank of St.


Louis
at
www.stls.frb.org).

RoseHudgins: Bank
Management and Financial
Services, Seventh Edition

204

II. Financial Statements


and Financial Firm
Performance

6. Measuring and
Evaluating the
Performance of Banks and
Their Principal
Competitors

Part Two Financial Statements and Financial Firm Performance

1 Federal
Books and Journals Focusing on Laws
and Regulations and International
Developments Affecting Banks and Other
Financial-Service Providers

1 International

Economic Conditions

(published by the

Federal Reserve Bank of St. Louis at www.stls.frb.org).

2 The

Reserve System
at
www.federalreserve.gov.

2 Federal

Reserve Bank
of
Minneapolis
at
www.minneapolisfed.org.

Industry Directories

Economist (London) (available by subscription;


Directories
information may be found at www.economist.com).

for
many
industries
give
lists
of
businesses in an industry by
Key Regulatory Agencies
name, city, state, and country
1 Office of the Comptroller of the Currency (OCC) at of location. Some of the more
complete directories provide
www.occ.treas.gov.
avenues of contact
2 Board of Governors of the Federal Reserve System essential
for directory users, such as
at www.federalreserve.gov.
the names of key offi-cers
3 Federal Deposit Insurance Corporation (FDIC) at within a firm and the
www. fdic.gov.
companys mailing address,
4 Office of Thrift Supervision at www.ots.treas.gov. tele-phone number, and email address. More detailed
Basic Education in Banking and Financial Services directories have abbreviated
financial statements of the
for Both Bankers and Their Customers
firms listed and may even
have a historical sketch about
Consumer Action at
www.consumeraction.org.
each firm. One common use

The McGrawHill
Companies, 2008

of these directories is to
pursue possible employment
opportunities. Among the
better-known
indus-try
directories are these:

1 The

Bankers Almanac at
www.bankersalmanac.c
om.

2 Investment Bankers Directory


at
www.chicagobusiness.com.

3 International

Insurance
Directory
(also
described at www.
insurancenetwork.com).

4 Directory

of Savings
and
Loans
at
www.abbycon.com/
financial.