Measuring and Evaluating Bank Performance

1. Measuring and Evaluating Bank Performance 6 July 2009 Ms. Kashmirr C. Ibanez

2. What is performance? • How adequately a financial firm meets the needs of its stockholders, employees, depositors and other creditors and borrowing customers • Keep regulators satisfied that operating policies, loans and investments are sound • Must be directed towards specific objectives FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

3. Value of the Bank’s Stock FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

4. 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 FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

5. Value of Bank’s Stock if Earnings Growth is Constant FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

6. Key Profitability Ratios in Banking ** use total earning assets for NIM and NNM FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

7. Key Profitability Ratios in Banking FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

8. Interpreting the key profitability ratios FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

9. Return to shareholder is sensitive to how its assets are financed • Financial institutions with low ROA can achieve a relatively high ROE through heavy use of debt (leverage) and minimal use of owner’s capital • As earnings efficiency (ROA) declines, the firm must take on more risk in the form of higher leverage to have any chance of achieving its desired ROE Zoom in on ROE FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

10. Zoom in on ROE FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

11. Zoom in on ROE FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

12. Achieving profitability depends on several crucial factors • Careful use of financial leverage • Proportion of assets financed by debt as opposed to equity capital • Careful use of operating leverage • Proportion of fixed cost inputs used to boost operating earnings as output grows • Careful control of operating expenses • Careful management of asset portfolio • Careful control of exposure to risk FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

13. Other measures of bank performance

14. All about risk • Risk • perceived uncertainty associated with a particular event • Deviation from expectations • Popular measures for overall risk for a financial firm • Standard deviation or variance of stock prices, net income, ROE or ROA FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

15. Measuring Bank Risks • Credit Risk • The probability that some of the bank’s assets will decline in value and perhaps become worthless • Liquidity Risk • Probability the bank will not have sufficient cash and borrowing capacity to meet deposit withdrawals and other cash needs • Market Risk • Probability of the market value of the bank’s investment portfolio declining in value due to a rise in interest rates FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

16. Bank Risks • Interest Rate Risk • The danger that shifting interest rates may adversely affect a bank’s net income, the value of its assets or equity • Earnings Risk • The risk to the bank’s bottom line – its net income after all expenses • Capital Risk • Probability of the value of the bank’s assets declining below the level of its total liabilities. The probability of the bank’s long run survival FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

17. Bank Risks • Legal risk • Creates variability in earnings resulting from actions taken by leval system (e.g. unenforceable contracts, lawsuits, adverse judgments • Compliance risk • Reaches beyond violation of the legal system and includes violations of rules and regulations. • Reputational risk • Uncertainty associated with public opinion • Strategic risk • Variations in earnings due to adverse business decisions, improper implementation of decisions or lack of responsiveness to industry changes FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

18. Credit Risk Measures • Nonperforming Loans/Total Loans • Net Charge-Offs/Total Loans • Provision for Loan Losses/Total Loans • Provision for Loan Losses/Equity Capital • Allowance for Loan Losses/Total Loans • Allowance for Loan Losses/Equity Capital • Total Loans/Total Deposits FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

19. Liquidity Risk Measures • Purchased Funds/Total Assets • Net Loans/Total Assets • Cash and Due from Banks/Total Assets • Cash and Government Securities/Total Assets FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

20. Market Risk Measures • BV of Assets/ MV of Assets • BV of Equity/ MV of Equity • BV of Bonds/MV of Bonds • MV of Preferred Stock and Common Stock FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

21. Interest Rate Risk Measures • Interest Sensitive Assets/Interest Sensitive Liabilities • Uninsured Deposits/Total Deposits FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

22. Earnings Risk Measures • Standard Deviation of Net Income • Standard Deviation of ROE • Standard Deviation of ROA FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

23. Capital Risk Measures • Interest rate spread between market yields on debt issues and market yields on GS with the same maturity • Stock Price/ Annual EPS • Ratio falls if investors believe that a financial firm is undercapitalized relative to the risk it is taking on • Equity Capital/Total Assets • Purchased Funds/Total Liabilities • Equity Capital/Risk Assets FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

24. Other Forms of Risk in Banking • Inflation Risk • Currency or Exchange Rate Risk • Political Risk • Crime Risk FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez

25. Don’t Forget to be FAIR! Compare institutions with similar… Size Location Regulation Target Market FINBANK SY 08-09 Term 2 Ms. Kashmirr C. Ibañez