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
62
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
63
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.
64
Value of the Bank’s Stock
65
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
66
Value of Bank’s Stock if Earnings Growth is
Constant
67
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
t1
(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
68
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
69
However, most capitalmarket 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
610
Key Profitability Ratios in Banking (cont.)
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 Fall '15
 Revenue, Generally Accepted Accounting Principles, total assets, Total Equity Capital, financial firm