33times high values for these ratios produce high

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9.33times High values for these ratios produce high ROEs, but, as noted, managers should be concerned about the source of high ROEs. For example, an increase in ROE due to an increase in the EM means that the bank’s leverage, and therefore its solvency risk, has increased. 18 We are using year-end balance sheet data to calculate ratios. The use of these data may bias ratios in that they are data for one day in the year, whereas income statement data cover the full year. To avoid this bias, average values for balance sheet data are often used to calculate ratios.
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Appendix 2B Commercial Banks’ Financial Statements and Analysis 25 Return on Assets and Its Components A further breakdown of a bank’s profitability is that of dividing ROA (ratio 2 in Table 2B–5) into its profit margin (PM) and asset utilization (AU) ratio components: ROA Net income Total operating income Total operating income Total assets PM AU where PM (ratio 4) Net income generated per dollar of total operating (interest and noninterest) income AU (ratio 5) Amount of interest and noninterest income generated per dol- lar of total assets For our two banks, these are as follows: Webster Financial Bancorp Bank of America PM 166.34 996.72 189.56 14.02% 20,609.28 80,161.52 33,673.20 18.10% AU 996.72 189.56 16,755.39 7.08% 80,161.52 33,673.20 1,439,598.50 7.91% Again, high values for these ratios produce high ROAs and ROEs. PM measures the bank’s ability to control expenses. The better the expense control, the more profit- able the bank. AU measures the bank’s ability to generate income from its assets. The more income generated per dollar of assets, the more profitable the bank. Again, bank managers should be aware that high values of these ratios may indicate underlying problems. For example, PM increases if the bank experiences a drop in salaries and benefits. However, if this expense decreases because the most highly skilled employ- ees are leaving the bank, the increase in PM and in ROA is associated with a potential “labor quality” problem. Thus, it is often prudent to break these ratios down further. Profit Margin As stated, PM measures a bank’s ability to control expenses and thus its ability to produce net income from its operating income (or revenue). A breakdown of PM, therefore, can isolate the various expense items listed on the income statement as follows: (ratios used to decompose the profit margin are listed in Table 2B–6) Interest expense ratio ratio 9 Interest e ( ) xpense Total operating income Provision for loan loss ratio ratio 10 Provision for l ( ) oan losses Total operating income Noninterest expense ratio ratio 11 Noninterest exp ( ) ense Total operating income Tax ratio ratio ( 12 Income taxes Total operating income )
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TABLE 2B–6 Decomposition of Profit Margin for Two Commercial Banks for 2007 Ratio Webster Financial Bancorp Bank of America Profit Margin Components 9. Interest expense ratio 38.40% 37.16% 10. Provision for loan loss ratio 1.14 5.33 11. Noninterest expense ratio 39.50 30.25 12. Tax ratio 6.94 9.15 Interest Expenses as a Percentage of Total Operating Income 13. NOW accounts 0.57% 0.18% 14. MMDAs and other savings 9.25 5.11 15. Foreign deposits 0.72 5.05 16. Retail CDs 13.54 3.85 17. Wholesale CDs
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