Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Measuring and Evaluating
Bank Performance
Chapter
5
The purpose of this chapter is to discover what analytical tools can
be applied to a bank’s financial statements so that management and
the public can identify the most critical problems inside each bank
and develop ways to deal with those problems.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Value of the Bank’s Stock

E(D t)
P0  
t
(1

r)
t 0
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Value of a Bank’s Stock Rises When:
 Expected
Dividends Increase
 Risk of the Bank Falls
 Combination of Expected Dividend Increase and Risk
Decline
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Value of Bank’s Stock if Earnings Growth is
Constant
D1
P0 
r-g
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Key Profitability Ratios in Banking
Net Income After Taxes
Return on Equity Capital (ROE) 
Total Equity Capital
Net Income After Taxes
Return on Assets (ROA) 
Total Assets
Net Interest Income
Net Interest Margin 
Total Assets
Net Noninteres t Income
Net Noninteres t Margin 
Total Assets
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Key Profitability Ratios in Banking (cont.)
Total Operating Revenues Total Operating Expenses
Net Bank Operating Margin 
Total Assets
Net Income After Taxes
Earnings Per Share (EPS) 
Common Equity Shares Outstandin g
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Breaking Down ROE
ROE = Net Income/ Total Equity Capital
ROA =
Net Income/Total Assets
Net Profit Margin =
Net Income/Total Operating Revenue
x
Equity Multiplier =
Total Assets/Equity Capital
Asset Utilization =
x Total Operating Revenue/Total Assets
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
ROE Depends On:
 Equity
Multiplier
 Leverage
 Net
or Financing Policies
Profit Margin
 Effectiveness
 Asset
of Expense Management
Utilization
 Portfolio
Management Policies
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Components of ROE for All Insured Banks
Year
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
ROE
14.92
12.72
11.94
13.87
14.19
14.31
15.13
12.18
8.00
7.48
7.63
=
=
=
=
=
=
=
=
=
=
=
=
NPM
14.01
12.17
13.32
12.88
12.68
13.37
13.47
10.01
5.32
4.36
4.24
X
X
X
X
X
X
X
X
X
X
X
X
AU
8.91
8.93
8.86
8.87
8.93
8.33
8.87
9.15
10.17
11.08
11.17
X
X
X
X
X
X
X
X
X
X
X
X
EM
11.95
11.77
11.94
12.14
12.53
12.85
12.66
13.30
14.77
15.48
16.11
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Bank Risks
 Credit
Risk
 Liquidity Risk
 Market Risk
 Interest Rate Risk
 Earnings Risk
 Solvency Risk
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Credit Risk
The Probability that Some of the Bank’s
Assets Will Decline in Value and Perhaps
Become Worthless
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Credit Risk Measures
 Nonperforming
Loans/Total Loans
 Net Charge-Offs/Total Loans
 Provision for Loan Losses/Total Loans
 Provision for Loan Losses/Equity Capital
 Allowance for Loan Losses/Total Loans
 Allowance for Loan Losses/Equity Capital
 Total Loans/Total Deposits
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Liquidity Risk
Probability the Bank Will Not Have
Sufficient Cash and Borrowing Capacity to
Meet Deposit Withdrawals and Other Cash
Needs
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Liquidity Risk Measures
 Purchased
Funds/Total Assets
 Net Loans/Total Assets
 Cash and Due from Banks/Total Assets
 Cash and Government Securities/Total Assets
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Market Risk
Probability of the Market Value of the
Bank’s Investment Portfolio Declining in
Value Due to a Rise in Interest Rates
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Market Risk Measures
 Book-Value
of Assets/ Market Value of Assets
 Book-Value of Equity/ Market Value of Equity
 Book-Value of Bonds/Market Value of Bonds
 Market Value of Preferred Stock and Common Stock
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Interest Rate Risk
The Danger that Shifting Interest Rates
May Adversely Affect a Bank’s Net
Income, the Value of its Assets or Equity
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Interest Rate Risk Measures
 Interest
Sensitive Assets/Interest Sensitive Liabilities
 Uninsured Deposits/Total Deposits
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Earnings Risk
The Risk to the Bank’s Bottom Line – Its
Net Income After All Expenses
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Earnings Risk Measures
 Standard
Deviation of Net Income
 Standard Deviation of ROE
 Standard Deviation of ROA
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Solvency or Default Risk
Probability of the Value of the Bank’s
Assets Declining Below the Level of its
Total Liabilities. The Probability of the
Bank’s Long Run Survival
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Solvency Risk Measures
 Spread
Between Bank CDs and Treasury Securities of
the Same Maturity
 Stock Price/Earnings Per Share
 Equity Capital/Total Assets
 Purchased Funds/Total Liabilities
 Equity Capital/Risk Assets
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Other Forms of Risk in Banking
 Inflation
Risk
 Currency or Exchange Rate Risk
 Political Risk
 Crime Risk
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Performance Measures Related to Bank Size
Performance Indicators
ROA
ROE
Net Operating Margin/TA
Net Interest Margin/EA
Net Noninterest Margin/EA
Operating Exp./Operating Rev.
PLL/Net Charge Offs
Net Charge Offs/Total Loans
ALL/Total Loans
Noncurrent Assets + Real Estate/TA
Net Loans/TotalDeposits
Equity Capital/TA
Yield on Earning Assets
Cost of Funding Earning Assets
All
Banks
1.31
15.34
1.30
4.07
-1.26
58.66
106.75
0.61
1.68
0.63
89.61
8.37
7.78
3.71
Under
$100
Mill.
1.01
9.07
1.02
4.44
-2.60
68.01
142.95
0.37
1.41
0.65
69.61
10.88
7.94
3.50
$100
Mill. To
$1 Bill.
1.36
14.24
1.34
4.59
-2.13
60.82
143.18
0.36
1.45
0.57
77.65
9.22
8.08
3.49
$1 Bill.
To $10
Bill
1.49
16.02
1.50
4.42
-1.33
55.73
112.99
0.68
1.82
0.58
91.19
8.49
7.98
3.56
Over
$10 Bill.
1.28
15.97
1.27
3.84
-0.97
58.46
99.82
0.66
1.71
0.66
93.98
7.14
7.65
3.81
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
UBPR
The Uniform Bank Performance Report
Provided by U.S. Federal Regulators so
that Analysts Can Compare the
Performance of One Bank Against Another
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.