CHAPTER SIX Measuring and Evaluating the Performance of Banks and Their Principal Competitors
Key Topics Stock Values and Profitability Ratios Measuring Credit, Liquidity, and Other Risks Measuring Operating Efficiency Performance of Competing Financial Firms Size and Location Effects 6-2
Evaluating Bank Performance Performance refer to how adequately a financial firm meets the needs of Stockholder Employee Depositors and creditors Borrowing customers Performance are under heavy scrutiny: Banks depend heavily upon the open market to raise funds In 2002 J.P.Morgan Chase’s credit rating came under review In 2007, Citigroup,Countrywide and Washington Mutual 6-3
Evaluating Bank Performance Two important dimensions of performance: Profitability Risk Objective: to maximize the value of the shareholders’ wealth at an acceptable level of risk. 6-4
Value of the Bank’s Stock 6-5
Value of a Bank’s Stock Rises When: Expected Dividends Increase Risk of the Bank Falls Market Interest Rates Decrease Combination of Expected Dividend Increase and Risk Decline 6-6
Value of Bank’s Stock if Earnings Growth is Constant 6-7 A stock whose dividends are expected to grow forever at a constant rate, g. D 1 = D 0 (1+g) 1 D 2 = D 1 (1+g) =D 0 (1+g) 2 D t = D t-1 (1+g) =D 0 (1+g) t If g is constant, the discounted dividend formula converges to: g r D g r g D P 1 0 0 1
Value of Bank’s Stock if Earnings Growth is Constant 6-8 For example, a bank is expected to pay a dividend of $5 per share in period 1, and dividends are expected to grow at 6% forever, and the discount rate to reflect risk is 10%, then the stock price could be valued at:
Value of Bank’s Stock if Earnings Growth is Constant 6-9 However, most capital-market investors have a limited time horizon and plan to sell the stock at the end of their investment horizon: Suppose investors expect a bank to pay dividend of $5 at the end of period 1, $10 at the end of period 2 and sell the stock for a price of $150 per share:
Key Profitability Ratios in Banking Assets Total Income Interest Net Assets Total expense) Interest - income (Interest Margin Interest Net Assets Total Income t Noninteres Net Assets Total expenses t Noninteres - PLLL - revenue t Noninteres Margin t Noninteres Net Net Income Return on Equity Capital (ROE) = Total Equity Capital Net Income Return on Assets (ROA) = Total Assets 6-10
Key Profitability Ratios in Banking (cont.)
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- Fall '15
- Revenue, Generally Accepted Accounting Principles, total assets, Total Equity Capital, financial firm