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CHAP_10_Measuring and evaluating the performance of banks and their principal competitors

CHAP_10_Measuring and evaluating the performance of banks and their principal competitors

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William Chittenden edited and updated the PowerPoint slides for this edition. MEASURING & EVALUATING THE PERFORMANCE OF BANKS Chapter 10
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Key topics 1. Stock values and profitability ratios 2. Measuring credit, liquidity, and other risks 3. Measuring operating efficiency 4. Performance of competing financial firms 5. Size and location effects 6. The UBPR and comparing performance 6-2
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Banks’ key objectives 1. Maximizing the bank value 2. Controlling wide-range risks
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Value of the bank’s stock 6-4
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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 6-5
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Value of bank’s stock if earnings growth is constant g - r D P 1 0 = 6-6
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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 6-7
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Key profitability ratios in banking (cont.) g Outstandin Shares Equity Common Taxes After Income Net (EPS) Share Per Earnings = Total Interest Income __ Total Interest Expense Earnings Spread = Total Earning Assets Total Interest Bearing Liability 6-8 Assets Total Expenses Operating Total - Revenues Operating Total Margin Operating Bank Net = Assets Total Assets Earning Base Earning =
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Breaking down ROE N e t P r o f i t M a r g i n = N e t I n c o m e / T o t a l O p e r a t i n g R e v e n u e A s s e t U t i l i z a t i o n = T o t a l O p e r a t i n g R e v e n u e / T o t a l A s s e t s R O A = N e t I n c o m e / T o t a l A s s e t s E q u i t y M u l t i p l i e r = T o t a l A s s e t s / E q u i t y C a p i t a l R O E = N e t I n c o m e / T o t a l E q u i t y C a p i t a l x x 6-9
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Return on equity (ROE = NI / TE) the basic measure of stockholders’ returns ROE is composed of two parts: Return on Assets (ROA = NI / TA), represents the returns to the assets the bank has invested in Equity Multiplier (EM = TA / TE), the degree of financial leverage employed by the bank
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Return on assets (ROA = NI / TA) can be decomposed into two parts: Asset Utilization (AU) income generation Expense Ratio (ER) expense control ROA = AU - ER = (TR / TA) - (TE / TA) Where: TR = total revenue or total operating income = Int. inc. + Non-int. inc. + SG and TE = total expenses = Int. exp. + Non-int. exp. + PLL + Taxes
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ROA is driven by the bank’s ability to: generate income (AU) and control expenses (ER) Income generation (AU) can be found on the UBPR (page 1) as: TA losses) ( gains Sec TA Inc. int. Non. TA Inc. Int. AU + + = Expense control (ER) can be found on the UBPR (page 1) as: TA PLL TA . Exp . int Non TA . Exp . Int ER * + - + = Note, ER* does not include taxes.
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ROE depends on: Equity multiplier=Total assets/Total equity capital Leverage or financing policies: the choice of sources of funds (debt or equity)
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