internal performance

Evaluating Bank Performance• Outline

– A Framework for Evaluating Bank Performance Internal Performance

External Performance

Presentation of Bank Financial Statements

– Analyzing Bank Performance with Financial Ratios Profit Ratios

Risk Ratios

– Internal Performance Evaluations Based on Economic Profit RAROC (Risk-Adjusted Return on Capital)

EVA (Economic Value Added)

A Framework for Evaluating Bank Performance

• Internal Performance– Bank planning (policy formulation)

Goals, budgets, strategic planning

– Technology

Computers, communications, payments

– Personnel development

Challenges (personal selling and geographic expansion)

Job satisfaction (training and compensation)


• External Performance– Market share

Earnings effects

Role of technology

– Regulatory compliance

Capital

Lending

Securities

Other

– Public confidence

Deposit insurance

Public image


• Presentation of Bank Financial Statements– Balance sheet (Report of Condition)

Assets: cash assets, loans, and securities

Liabilities: deposit funds and nondeposit funds

Capital: equity capital, subordinated notes and debentures, loan loss reserves

– Income Statement (Report of Income)

Interest income

Noninterest income

Interest expenses

Noninterest expenses (including provision for loan losses)

Net profit

Analyzing Bank Performance with Financial Ratios

• Profit ratios– Rate of return on equity

ROE = NI/TE (net income after taxes/total equity)

– Rate of return on assets

ROA = NI/TA (net income after taxes/total assets)

– Other profit measures

Net interest margin

NIM = (Total interest income - Total interest expense)/Total assets

Note: municipal bond interest is not taxable, such that it must be grossed up to a pre-tax equivalent basis by dividing munis interest earned by the factor (1 - tax rate of bank).


• Profit ratios– Unraveling profit ratios

ROE = ROA x TA/TE (total assets/total equity or equity multiplier).

Thus, by decreasing equity, a bank can increase ROE based on any given level of ROA.

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

The NI/OR ratio is the profit margin, while OR/TA reflects asset utilization. By using this breakdown, one can make inferences

concerning the reason for say increases in ROE. If asset utilization and equity multiplier did not change, the profit

margin must have increased due to cost savings pushing this ratio up.


• Risk ratios– Capitalization

Leverage ratio

Total equity/Total assets

Total capital ratio

(Total equity + Long-term debt + Reserve for loan

losses)/Total assets

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


• Risk ratiosAsset quality

Provision for loan loss ratio = PLL/TL (provision for loan losses/total loans and leases)

Loan ratio = Net loans/Total assetsLoss ratio

= Net charge-offs on loans (gross charge-offs minus recoveries)/Total loans and leases

Reserve ratio = Reserve for loan losses (reserve for loan losses last year

minus gross charge-offs plus PLL and recoveries)/Total loans and leases

Nonperforming ratio = Nonperforming assets (nonaccrual loans and restructured loans)/Total loans and leases


• Risk ratios– Operating efficiency (cost control)

Wages and salaries/Total expenses

Fixed occupancy expenses/Total expenses– Liquidity

Temporary investments ratio

= (Fed funds sold, short-term securities, cash, trading account

securities)/Total assets

Volatile liability dependency ratio

= (Total volatile liabilities - Temporary investments)/Net loans

and leases

Note: This ratio gives an indication of the extent to which “hot” money is being used to fund the riskiest assets of the bank.


• Other financial ratios– Tax rate = Total taxes paid/Net income before taxes

– Dollar gap ratio

= Interest rate sensitive assets - Interest-rate sensitive liabilities

Total assets

where rate-sensitive means short-term with maturities of less than one year (or repriced in less than one year).

internal performance

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