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Topic 3a Bank Performance Ratios

Areas of Coverage Balance Sheets for Commercials Banks Income Statement Overall performance measures Broad Risk Measures

Topic 3a Bank Performance Ratios

Commercial Bank Balance Sheet and Income


Balance Sheet All Assets Investment Securities Loans and Leases Liabilities and Equity Income Statement Net Income Interest Income Interest Expenses Noninterest Income and Expenses Provisions for Likely Loan Losses Chargeoffs and Recoveries

Commercial Banks
Off-Balance Sheet Activities
Total unused commitment Letters of credit Participations in acceptances Mortgages that have been transferred (sold or unsold) with recourse When-issued securities Interest rate contracts Foreign exchange contracts Contracts on other commodities and equities All other

Overall Performance Measures


Return on Assets (ROA) (Net Income /Average Assets) x 100 Return on Common Equity (ROE) (Net Income /Average Common Equity) x 100 Common Equity Ratio (Average Common Equity / Average Assets ) x 100 Net Interest Margin (Interest Income Interest Expense)/Average assets

Equity Capital
+ + + + + = Preferred stock and preferred surplus Common stock and surplus Retained earnings Unrealized gains (losses) on available for sale securities Foreign currency adjustments Treasury stock Total equity capital

Note: these ratios are calculated using the income variable over the measurement period but using the average assets or average common equity over the measurement period If averages are not available, they may be approximated by using end of quarter data or even year-end data for adjacent quarters or years

Common equity = total equity less preferred stock and preferred surplus

ROE and Leverage


ROE = (Net income/Average common equity) x 100 Leverage multiplier equity = Average assets/Average common = 1 / Common equity ratio ROA = (Net income/ Average Assets) x 100 ROE = (ROA x Leverage multiplier) x 100 = (ROA / Common equity ratio) x 100

Common Equity
Recall that this is: + Common stock plus surplus + Retained earnings + Unrealized gains (losses) on listed as available for sale securities + Foreign currency adjustments Treasury stock + Retained Earnings = Common equity Common equity is the shareholders interest in the firm

ROE
Return on common equity = (net income available for common / average common equity) x 100 (return on average assets x leverage multiplier)

Leverage and Performance


As the common equity ratio rises, leverage falls For the same ROA this leads to a lower ROE E.g., suppose ROA = 1.03% Leverage = 20 ROE = 20.6%

BUT if leverage multiplier drops to 12.0 because capital ratio rise to 8.3333%, ROE drops to 12.36%

Net Interest Income


NII = Interest Income Less Interest Expense Interest Income Interest earned on each asset = asset x yield or Total earning assets x average yield Interest Expense Interest paid on each liability = liability x rate or Total liabilities x average rate

Noninterest Income
Trust fees Other Service charges on deposits Brokerage Nondeposit related fees Trading profits and fees Safe deposit income FX income Mortgage servicing & related fees BAs and LOCs Fees on factored accounts rec. Ins commissions & earnings Investment banking income Misc. Other service fees Credit card income Merchant discount fees Annual card fees Other card fees

Noninterest Expenses
Personnel Occupancy, net Other Equipment Marketing Professional fees Amortization of intangibles Credit cards Private Label Cards FDIC Insurance Telecommunication Postage and courier Other general operating

Constructing the ROA


ROA = + Net interest margin
Ratio of interest income less interest expense to average assets

+ -

Overhead Ratio
Ratio of noninterest income less noninterest expense to average assets

Provision Margin
Ratio of provisions for possible tosses to average assets

Tax Margin
Ratio of taxes to average assets

Separating the ROA


This can be expanded to reflected the combination of Net profit margin which captures which measure cost management and Asset utilization which measures revenue management
NetIncome NetIncome Revenues = Assets Revenues Assets

Market Capitalization
Two components: Fair value of the assets less the liabilities Affected by interest rate risk Value of the bank charter (franchise value) Affected by perception of
Interest rate risk Credit Risk Liquidity Risk Operating Efficiency Capital

If expenses rise relative to revenues the net profit margin will fall If revenue rises relative to assets, asset utilization rises

Risks
Credit risk: risk of delays in the timely payment of interest and principal Liquidity: the ability to gather funds to assure the continued day-to-day operations Make loans Honor claims against the institution Check presented for collection Liabilities that have matured Liquidity risk: the risk that an institution will not be able to gather funds for dayto-day operations Interest rate risk: Variability in net interest income arising from shifts in the level of interest rates and/or shifts in the shape of the yield curve Variability in the market value of net worth arising from shifts in the level of interest rates and/or shifts in the shape of the yield curve Capital risk Risk that capital may be insufficient to support asset growth The risk that capital may be insufficient to support current footing (triggering prompt action

Credit Quality
Size and Credit Quality Net loans and leases to total asset Loan loss provision to average total loans and leases Loan loss allowance to total loans and leases + Loan loss allowance to nonaccural loans + Loan loss allowance to net loans + Noncurrent loans and leases to gross loans and leases Earnings coverage to net losses + Net loss to average loans and leases Growth rate in net loans and leases -

Credit Quality Allowance for Loan Losses


+ + = Last periods allowance for loan losses This periods provisions This periods charge offs This periods recoveries This periods allowance for loan losses

Liquidity Risk
Size and relation to liquidity Net loans and leases to assets Net loans and leases to total deposits assets Securities with maturity < 1 year to total assets Volatile liabilities to assets Core deposits to assets + (sec with matuirity < 1 year less 1-year volatile liabilities) to assets Unused loan and lease commitments to asset Standby letters of credit to assets assets -

Capital Risk
Size and relation to capital risk + + + + +

Operating Expenses

Equity (tier 1) to average assets Cash dividends to net income Tier 1 capital to risk-weighted assets Tier 1+ Tier 2 to risk weighted capital Growth rate of Tier 1 equity capital Growth rate of assets Equity growth less asset growth

Average personnel expenses per employee ($000) Asset per employee ($ million) Total overhead expense to assets Personnel expense to average assets Occupancy expense to average assets

Size and relation to opearting efficiency + -

Productivity
Average Assets per Employee Personnel Expenses per Employee The Efficiency Ratio Noninterest Income / Average Assets Noninterest Expenses / Average Assets Personnel Expenses / Average Assets Occupancy Expenses / Average Expenses Other Expenses /Average Assets Net Overhead = Noninterest Expense Less Noninterest Income Noninterest Income / Noninterest Expenses .

Efficiency Ratio
The dollar cost of one dollar of income

efficiency =

noninterest.expense netinterest + noninterest.income

Net Overhead Ratio


The dollar cost of assets

NetOHRatio =

NoninterestExpense OninterestIncome AverageAssets