My Website Contains Useful Information

Bank Financial Analysis

http://www.westga.edu/~rbest/GSB.html

Graduate School of Banking @ LSU

Information that will help you complete the

home study problem

Ron Best
Professor of Finance
University of West Georgia

Information about accessing your banks UBPR

Richards College of Business

Department of Accounting and Finance
Carrollton, Georgia 30118
rbest@westga.edu
678-839-4812

Spreadsheet template

Overview

Financial Intermediation

Financial Statements and Ratios

A banks primary purpose is financial

intermediation
Accept deposits
Usually short-term in nature
Relatively quick interest rate adjustments
possible
Make loans
Variety of maturities
Fixed and variable rates
Make money through an interest rate spread
and by charging for services provided

Decomposition of ROE
Bank Risk
Putting it all Together
Review
3

The Goal of Bank Management

Purpose of Financial Analysis

What is the goal of bank management?

Measure past performance

Maximize the value of the bank

Determine starting point for planning

Asset Value/Price
Present value of expected future cash flows
Bank management must determine the
appropriate balance between risk and return
Higher expected profitability often goes handin-hand with additional risk
Higher profit does not always translate into
higher value

Estimate future performance (What-ifs?)

Set values
Predict cashflows
Determine risk
5

Why use ratios?

Warning!

Standardize numbers; facilitate comparisons

Be careful not to infer too much from a ratio

The most common comparison norms are:

Accounting discretion makes a difference

Changes often affect multiple ratios differently

Approaches to loan loss expenses & write-offs

Past performance
Other
Oth banks
b k (peer
(
or target
t
t banks;
b k industry
i d t (or
(
peer group) average/median)

Calculating ratios is mechanical and their

relationships are often mechanical, but
interpreting underlying causes is not
Ratios help you ask the right questions,
but by themselves, they rarely give you
all the answers

Look at trends over time (trend analysis) for

clues to whether a banks financial condition
is likely to improve or to deteriorate
7

CAMELS

Readily Available Data

Uniform Bank Performance Report (UBPR) Federal Financial Institutions Examination
Council (FFIEC)

Capital Adequacy
Asset Quality
Management Quality
Earnings
Liquidity
Sensitivity

Created
C eated for
o ba
bank supe
supervisory,
so y, e
examination,
a
at o ,
and management purposes
Bank's performance and balance-sheet
composition
earnings, liquidity, capital, asset and liability
management, and growth management
9

Bank Data

10

Financial Statements
Balance Sheet

FFIEC: UBPR
https://cdr.ffiec.gov/public/ManageFacsimiles.aspx

Assets = Liabilities + Equity

Balance sheet figures are calculated at a
particular point in time

Income Statement

FDIC Statistics on Depository Institutions

Net Income = Revenues Expenses

Indicates results over a period of time

http://www2.fdic.gov/sdi/index.asp

11

12

Balance Sheet
Cash & DFB

Bank Assets
Cash and due from banks

Deposits

Vault cash, deposits held at the Fed and other financial

institutions, and cash items in the process of collection

Non-interest Bearing
Interest Bearing

Investment
Securities

Investment Securities

Purchased Liabilities

Bonds, notes, and other securities held to generate

return and help meet liquidity needs

Fed Funds
Repos
Other S-T Liab

Loans
Other Assets

Loans
Commercial, consumer, RE, agricultural, etc.
Generate most of interest income; highest default risk

LT Sub. Debt
Equity Accounts

Other assets
Bank premises and equipment, interest receivable,
prepaid expenses, other real estate owned
13

14

Bank Investments

Transaction Accounts

Held-to-maturity securities recorded on the

balance sheet at amortized cost
Trading account securities actively bought
and sold marked to market on balance
sheet and gains and losses reported on
income statement
Available-for-sale recorded at market value
on balance sheet with a corresponding
change to stockholders equity as value
changes; no income statement impact

Non-interest bearing demand deposits

Regular checking accounts that pay no interest

Interest bearing
Negotiable orders of withdrawal (NOWs) and
automatic transfers from savings (ATS)
Pay interest rate set by bank
Money market deposit accounts (MMDAs)
Pay market rates, but customer is allowed a
limited number of checks or automatic
transfers each month

15

16

Savings and Time Deposits

Other Borrowings

Savings and time deposits often represent

the bulk of interest-bearing liabilities
Two general time deposits categories exist:

Purchased liabilities (rate-sensitive):

Federal Funds Purchased
Repurchase agreements
Other borrowings less than one year

Jumbo (negotiable) certificates of deposit (CDs)

Time deposits in excess of $100
$100,000
000
Generally follow highest rate
Small retail CDs
Under $100,000
Considered core deposits which tend to be
stable deposits that are typically not
withdrawn over short periods of time.

Subordinated notes and debentures:

Notes and bonds with maturities over one year

Generally, from least to most expensive

17

Demand deposits
Savings deposits
Time deposits
Purchased liabilities
18

Bank Balance Sheets by Asset Size - 2010

Stockholders equity
Ownership interest in the bank
Common and preferred stock listed at par
Surplus account represents the amount of
proceeds received by the bank in excess of par
when it issued the stock
Retained earnings equals accumulated net
income not paid out as cash dividends
19

Income Statement

Cash and Due

Securities
FF Sold
Net Loans
LL Allow
Trading Acct
Bank Premises
Other Assets
Total Assets

< $100M
13,256,267
29,949,725
4,402,033
77,176,882
1,389,083
11,591
2,307,348
4,841,455
131,945,301

$100M - $1B
79,440,913
213,817,470
16,065,850
680,336,280
13,921,325
157,266
20,184,662
48,624,471
1,058,626,912

$1B - $10B
87,912,852
223,629,694
7,386,095
679,566,993
17,036,426
1,952,625
15,945,198
73,997,841
1,090,391,298

> $10B
742,489,011
1,884,243,297
426,501,368
4,940,678,681
184,979,558
719,167,669
72,233,013
1,001,326,459
9,786,639,498

Total Dep
FF Purch
Trading Liab
Other Borrow
Total Liab
Preferred
Total CE
Total L & E

112,038,834
712,936
246
4,117,643
116,869,659
53,361
15,022,281
131,945,301

884,022,292
17,811,129
15,482
50,383,231
952,232,134
703,068
105,691,710
1,058,626,912

841,932,762
49,734,897
306,929
74,718,167
966,692,755
1,839,106
121,859,437
1,090,391,298

6,676,292,164
460,130,931
287,730,266
1,241,473,095
8,665,626,456
3,923,131
1,117,089,911
9,786,639,498
20

Income Statement Items

Interest Income
- Interest Expense
Net Interest Income
- Provision for Loan Losses
+ Noninterest Income
- Noninterest Expense
+ Gains/Losses on Secs
Pretax Earnings
- Taxes
Net income

Net interest income is interest income minus

interest expense
Interest income: interest income and fees
earned on loans and leases, deposits held at
other institutions, securities, fed funds sold
Interest Expense: interest paid on deposits,
fed funds purchased, Repos, other
borrowings, and sub. notes and debentures

Provision for Loan Losses

Noncash expense representing funds put aside
to prepare for bad loans
21

Noninterest income

22

Noninterest Expense

Fiduciary activities

Personnel expense

Managing and protecting a customers property

Recordkeeping for security transactions
Managing pension and retirement plans

Salaries and benefits paid to bank employees

Occupancy expense
Rent and depreciation on equipment and
premises and
premises,

Service charges

Other operating expenses

Fees for maintenance, overdraft, stop payments

Utilities
Deposit insurance premiums

Other
Investment banking
Venture capital revenue
Insurance commission fees

Note: Burden =
Non-interest expense minus non-interest income
23

24

Common Size Financial Statements

Bank Income Statements by Asset Size - 2010

Int Inc
- Int Exp
Net Int Inc
- PLL
+ Non Int Inc
- Non
N IIntt E
Exp
+ Sec G/L
Inc Bef Ext
+ Ext Inc
- Taxes
Net Inc

< $100M $100M - $1B

6,151,468
50,008,667
1,485,199
12,844,480
4,666,269
37,164,187
702,524
9,092,458
1,553,177
9,488,222
5 001 167
5,001,167
33 363 038
33,363,038
61,265
640,238
577,020
4,837,151
-384
34,478
110,812
1,310,146
465,824
3,561,483

$1B - $10B
48,579,075
11,663,894
36,915,181
13,802,500
14,236,852
33 017 009
33,017,009
475,924
4,808,448
-2,948
2,776,820
2,028,680

> $10B
376,775,949
63,354,759
313,421,190
122,374,086
192,469,437
287 331 790
287,331,790
7,115,710
103,300,461
-597,387
28,956,516
73,746,558

Initial comparison ratios

Balance sheets and income statements that
display all items relative to a common base
figure (such as total assets)
Allows quick identification of differences
Over Time
Across Banks
Across Groups

25

26

Common Size Bank Balance Sheets by Asset Size - 2010

Cash and Due
Securities
FF Sold
Net Loans
LL Allow
Trading Acct
Bank Premises
Other Assets
Total Assets

< $100M $100M - $1B

10.05%
7.50%
22.70%
20.20%
3.34%
1.52%
58.49%
64.27%
1.05%
1.32%
0.01%
0.01%
1.75%
1.91%
3.66%
4.59%
100.00%
100.00%

Total Dep
FF Purch
Trading Liab
Other Borrow
Total Liab
Preferred
Total CE
Total L & E

84.91%
0.54%
0.00%
3.13%
88.58%
0.04%
11.38%
100.00%

83.51%
1.68%
0.00%
4.76%
89.95%
0.07%
9.98%
100.00%

$1B - $10B
8.06%
20.51%
0.68%
62.32%
1.56%
0.18%
1.46%
6.79%
100.00%

> $10B
7.59%
19.25%
4.36%
50.48%
1.89%
7.35%
0.74%
10.24%
100.00%

77.21%
4.56%
0.03%
6.86%
88.66%
0.17%
11.17%
100.00%

68.22%
4.70%
2.94%
12.69%
88.55%
0.04%
11.41%
100.00%

Income Statements (% TA) by Asset Size - 2010

Int Inc
- Int Exp
Net Int Inc
- PLL
+ Non Int Inc
- Non
N IIntt Exp
E
+ Sec G/L
Inc Bef Ext
+ Ext Inc
- Taxes
Net Inc

< $100M $100M - $1B

4.73%
4.77%
1.14%
1.22%
3.59%
3.54%
0.54%
0.87%
1.19%
0.90%
3 84%
3.84%
3 18%
3.18%
0.05%
0.06%
0.45%
0.45%
0.00%
0.00%
0.09%
0.12%
0.36%
0.33%

$1B - $10B
4.47%
1.07%
3.40%
1.27%
1.31%
3 04%
3.04%
0.04%
0.44%
0.00%
0.26%
0.18%

27

28

Income Statement and Balance Sheet

How Do We Measure Return?

The income statement represents the results

over a period of time such as one year
The balance sheet represents a point in time
Use average balance sheet values from
corresponding dates of the income
statement
For example:

ROE = Net Income

Equity

Average Equity =

> $10B
3.88%
0.65%
3.23%
1.26%
1.98%
2 96%
2.96%
0.07%
1.06%
-0.01%
0.30%
0.75%

Return on Equity

Amount of net income generated by each book

value dollar of shareholder equity

ROA = Net Income

Assets

Equity t + Equity t 1
2

Return on Assets

Amount of net income generated by each book

value dollar of assets
29

30

ROE Example
2010
3154
503

Equity
Net Income

ROA =

Ratio Basics
2009
3371
521

ROE = Net Income

Equity

503
= 0.1541 = 15.41%
3 154 + 3,371
3 371)
(3,154

ROE increases:
If NI increases faster than Equity increases
If Equity decreases faster than NI decreases

What would happen to ROE if year-end equity

were used?
Note: The UBPR uses quarterly values to determine
average values for many items.

ROE decreases:
If NI decreases faster than Equity decreases
If Equity increases faster than NI increases
31

Return on Equity

Strategic Relationship

ROE and ROA are related through degree of

financial leverage (EM = Equity multiplier)

Equity
Ratio
Eq/TA
5.00%
6.00%
7.00%
8.00%

ROE
Net Income
Equity

ROA
Net Income
Assets

32

EM
Assets
Equity

Equity
Mult.
TA/Eq
20.0
16.7
14.3
12.5

x
x
x
x
x

ROA
1.50%
1.50%
1.50%
1.50%

=
=
=
=
=

ROE
30.0%
25.0%
21.4%
18.8%

Higher financial leverage (lower equity)

increases ROE

1
EM = Assets =
Equity Equity ratio
33

34

Camel Trail C (and L)

Capital Ratios

Bankers recognize that using less capital

magnifies earnings
Regulators prefer more capital to ensure
safety and soundness when unfavorable
events occur
Need for Capital Adequacy

Equity Ratio = equity/total assets

Risk-based capital requirements

Tier 1(Core Capital)

4 percent
Risk Adjusted Assets
Texas Ratio

Increasing EM (decreasing capital) magnifies

return but:
Increases failure risk

value of the lender's non-performing assets

(Non performing loans + Real Estate Owned)
divided by the sum of its tangible common
equity capital and loan loss reserves

Increases cost (availability) of uninsured funds

Increases interest expense ..
35

36

ROE Breakdown Over Time

Variable

2010

2009

2008

ROE

8.02%

7.69%

7.52%

EM

7 71
7.71

7 18
7.18

6 71
6.71

ROA

1.04%

1.07%

1.12%

What-If Analysis *****

Ratios can be used to calculate what-ifs
All else equal, calculate the banks ROE if it
had kept the same EM in 2010 as in 2009?
ROE = ROA X EM
ROE (act) = 1.04% X 7.71 = 8.02%
ROE (est) = 1.04% X 7.18 = 7.47%

Analysis:

What cost was borne to produce the higher

ROE? Was it desirable?
37

ROE Breakdown Over Time

Variable

2010

2009

2008

ROE

7.52%

7.69%

8.02%

EM

6 71
6.71

7 18
7.18

7 71
7.71

ROA

1.12%

1.07%

1.04%

38

ROE Breakdown Versus Peer Group

Analysis:

Bank
ROE
EM
ROA

2010
8.02%
7.71
1.04%

2009
7.69%
7.18
1.07%

2008
7.52%
6.71
1.12%

Peer Group
ROE
EM
ROA

2010
8.02%
9.214
0.87%

2009
7.69%
8.352
0.92%

2008
7.52%
7.601
0.99%

39

40

ROE Breakdown Versus Peer Group

Bank
ROE
EM
ROA

2010
8.02%
7.71
1.04%

2009
7.69%
7.18
1.07%

2008
7.52%
6.71
1.12%

Peer Group
ROE
EM
ROA

2010
7.09%
6.881
1.03%

2009
7.14%
6.732
1.06%

2008
7.46%
6.662
1.12%

Return on Assets
ROA is determined by the Profit Margin (PM)
and Asset Utilization (AU)
ROA
Net Income
Assets

AU
Revenue
Assets

PM
Net Income
Revenue

AU mix and yield on asset portfolio; generation of

revenue given assets
PM effectiveness of expense management
41

42

ROE Breakdown

ROE Breakdown Over Time

ROE
ROA
AU

EM

PM

Variable

2010

2009

2008

ROE

8.02%

7.69%

7.52%

7.71
7
71
1.04%

7.18
7
18
1.07%

6.71
6
71
1.12%

7.31%
14.23%

7.33%
14.60%

7.37%
15.20%

EM
ROA

EM

Return on equity depends on

AU
PM

Asset Utilization (AU)

Profit Margin (PM)
Equity Multiplier (EM)
43

ROE Breakdown Over Time

Variable

2010

2009

2008

ROE

8.02%

7.69%

7.52%

7.71
7
71
1.04%

7.18
7
18
1.07%

6.71
6
71
1.12%

6.85%
15.18%

7.00%
15.29%

7.37%
15.20%

EM
ROA
AU
PM

44

ROA Breakdown Versus Peer Group

Case 1
ROA
AU
PM

Bank
1.04%
7.31%
14.23%

PG
0.87%
5.73%
15.18%

What are different implications?

Case 2
ROA
AU
PM

Bank
1.04%
7.31%
14.23%

PG
0.87%
7.55%
11.52%

45

46

Income Statement
Net Income

Revenue

Asset Utilization
Expense

AU

Interest Income
- Interest Expense
Net Interest Income
- Provision for Loan Losses
+ Noninterest Income
- Noninterest Expense
+ Gains/Losses on Secs
Pretax Earnings
- Taxes
Net income

Int Inc
TA

47

Non Int Inc

TA

G/L
TA

48

AU Breakdown Over Time

Variable

2010

2009

AU
II/TA
Non II/TA
GL/TA

7.31%
5.79%
5
79%
1.52%
0.00%

7.33%
6 06%
6.06%
1.27%
0.00%

Interest Income to Total Assets

Interest Income
Assets

Interest Income
Earning Assets

Earning Assets
Assets

Yield on
Earning Assets

Real World:
Why are banks worried about loss of fee income?

Earnings
Base
50

49

AU Breakdown Over Time

Yield on Earning Assets

n

Variable

2010

2009

II/TA
EA/TA
II/EA

5.79%
90.14%
6.42%

6.06%
88.72%
6.83%

yiAi
Int Inc
i =1
Yield on EA =
=
EA
EA
where:

More earning assets ---- more income

yi = yield on asset i
Ai = dollar amount of asset i

What impacts yield on EA?

51

Interest Income
Asset

Non earning

50

52

Composition Analysis: Rate Change

i%

Inc

Asset

i% Inc

i+

Inc+

Non earning

50

Securities

100 x

Securities

100

Bus Loans

200 x

10

Bus Loans

200

10

12

Cons Loans

200 x

12

Cons Loans

200

12

16

25
5.0%
90.91%
4.55%

Int Inc
Int Inc/EA
Int Inc/TA

Int Inc
Int Inc/EA
EA/TA
Int Inc/TA

25
5.0%
4.55%

$32
6.4%
5.82%

Is the rate change good?

53

54

Assets: Composition Change

Asset

Assets: Rate and Composition Change

i%

Inc

New

Inc

Non earning

50

50

Securities

100

100

Bus Loans

200

10

300

15

Cons Loans

200

12

100

Int Inc
Int Inc/EA
Int Inc/TA

$25
5.0%
4.55%

$24
4.8%
4.36%

Which is better?

i%

New
i% amt

Change due to:

Rate Comp Both

Non earn 50

50

Sec

100

100

+1

B Loans

200

300

+2

+5

+1

C Loans

200

100

+4

-6

-2

$30
6.0%
5.45%

+7

-1

-1

Asset

Int Inc
Int Inc/EA
Int Inc/TA

$25
5.0%
4.55%

Notice the interaction effect

55

Changing Interest Income to Total Assets

Volume of Earning Assets

Camel Trail A
How can a bank increase rates across all
categories of loans?

Earnings base = EA / TA

Accept more risk loans

What is the impact?

Yield on Earning Assets

Composition of assets (mix)
Size of holdings across and within major
categories
Individual asset yields (average rate earned)
Maturity/Repricing
Timing
Default risk
Pricing expertise

How can overall asset yield be increased

without changing credit risk accepted for
each type of asset?
Increase amount of riskier assets
What is the impact?
57

58

Non-Interest Income
Non II
TA

Fid Fees
TA

Dep Svc
TA

56

Gains/Losses on Securities
+

Other
TA

G/L
TA

Fee income measured relative to asset

categories or number of employees

G/L
SEC

SEC
TA

Gains/Losses relati
relative
e to le
level
el of sec
securities
rities
and securities as percentage of assets

Deposit service charges to Deposits

Breakdown of categories to reveal results of

focus areas

Further breakdowns by category

Importance of potential gains/losses?
59

60

10

ROE Breakdown
AssetUtilization2010

ROE

7.00%
6.00%

ROA

5.00%
4.00%

IntInc

3.00%

NonII

2.00%

GL

AU

EM

PM

EM

Return on equity depends on

1.00%

Asset Utilization (AU)

Profit Margin (PM)
Equity Multiplier (EM)

0.00%
1.00%

<100M(2009)

<100M(2010)

>10B(2010)

>10B(2009)

61

62

Alternative Version of Profit Margin

Alternative Version of ROA

Net Income
Revenue
NI

= Revenue

Expense

Revenue
Assets

So
Net Income
=
Revenue

Revenue
Revenue

Asset Utilization

ROA

Expense
Revenue

Expense
Revenue

Asset Utilization
Revenue
Assets

Total Exp Ratio

Expense
Assets

63

Income Statement
Net Income

Revenue

M lti l i th
Multiplying
through
h we get:
t

Expense
Revenue

Profit Margin

64

Total Expense Ratio Components

Expense

Expense
Assets

Interest Income
- Interest Expense
Net Interest Income
- Provision for Loan Losses
+ Noninterest Income
- Noninterest Expense
+ Gains/Losses on Secs
Pretax Earnings
- Taxes
Net income

IE
TA

Non IE
TA

PLL
TAX

TA
TA

IE = Interest Expense
Non IE = Non-Interest Expense
PLL = Provision for Loan Losses
TAX = Taxes
65

66

11

Interest Expense to Total Assets

Interest Expense to Assets

Interest Expense
Assets

Interest Expense
Int Bearing Liab

ciLi
Int Exp
i =1
Cost Rate on IBL =
=
IBL
IBL

Int Bearing Liab

Assets

where:
Cost Rate on
Int Bearing Liab

Int Bearing Liab

as % of Assets

ci = cost rate on asset i

Li = dollar amount of asset i

67

68

Liabilities: Rate Change

Liab

i% Exp New i%

Liabilities: Composition Change

New Exp

Liab

i%

Exp New amt

New Exp

DDAs

100

DDAs

100

100

NOWs

200

NOWs

200

100

MMD
MMDs

100

MMD
MMDs

100

150

CDs

100

CDs

100

150

4.5

Int Exp
Int Exp/IBL
Int Exp/TA

$7
1.75%
1.27%

$12
3.0%
2.18%

Int Exp
Int Exp/IBL
Int Exp/TA

Equity = 50

69

Liabilities: Rate and Composition Change

Liab

i%

New
i% amt

Change due to:

Rate Comp Both

100

100

NOWs

200

100

+2

-1

-1

MMDs

100

150

+1

+1

+0.5

CDs

100

150

+2

+1.5

+1

+5

+1.5

+0.5

Equity = 50

$7
1.75%
1.27%

$14
3.5%
2.55%

$8.5
2.125%
1.55%

Equity = 50

70

Interest Expense to Assets

Volume of interest bearing liabilities
Cost rate on interest bearing liabilities

DDAs

Int Exp
Int Exp/IBL
Int Exp/TA

$7
1.74%
1.27%

71

Composition of liabilities
Size of holdings across and within various
types of liabilities
Cost per liability (average rate paid)
Differences in risk premiums
Timing of borrowing
Maturity of borrowing
Pricing expertise
72

12

Camel Trails L and S

Non-Interest Expense
Personnel
TA

How does current level of borrowing impact

liquidity?

Personnel
# Employees

# Employees
TA

If Personnel / TA is high, then:

Personnel / # employees is high, and/or
# Employees / TA is high

How does type of borrowing impact liquidity?

Occupancy
TA

How do both impact sensitivity to market?

Occupancy
# Branches

# Branches
TA

If Occupancy / TA is high, then:

Occupancy / # Branches is high, and/or
# Branches / TA is high

Asset quality and capital?

Composition effects may exist

73

More deposits then more overhead

Non Interest Expense

Variable
Non IE / TA
Pers / TA
Occup / TA
Other / TA

2010
3.33%
1.79%
0.36%
1.18%

2009
3.22%
1.75%
0.39%
1.08%

74

Provision for Loan Losses

PG
3.29%
1.65%
0.46%
1.15%

PLL
TA

PLL
Loans

Loans
TA

Provision for Loan Losses

Funds put aside to prepare for bad loans

Large PLL / Loans may indicate

What goes in the other category?

New risky loans

Overall risk of loan portfolio (catch-up)
Safety conscious management
75

Provision for Loan Losses

76

Camel Trail A
Loss experience

Variable

2010

2009

PG

PLL / TA

1.19%

0.37%

0.89%

0.52%
0
52%
71.17%

1.28%
1
28%
69.62%

PLL / Loans
L
1 71%
1.71%
Loans / TA 69.64%

Gross losses, net losses, and recoveries to average total loans and
leases
Recovery percentages and losses by loan type

Future expected/possible losses

Non-current
Non-current, total past due
due, and restructured loans to total loans
Examination by loan type
Market

Bank preparation
Provision for loan loss to average assets and loans
Allowance for loan losses to net losses and total loans
Earnings coverage of net loss

Analysis:

77

78

13

Taxes
TAX
TA

TAX
Taxable Inc

Taxable Inc
REV

TotalExpenseRatio

REV
TA

7.00%
6.00%

If Taxes/ TA is high, then:

5.00%

The tax rate may be high

Increase over time could indicate tax rate
changes or different tax rate environments
Revenue may be high
Good by itself
Taxable income may be high
Less use of tax advantaged assets

IntExp

4.00%

NonIE

3.00%

PLL

2.00%

TAX

1.00%
0.00%
<100M(2009)

<100M(2010)

>10B(2010)

>10B(2009)

79

80

Components of ROA

ROA

Asset Utilization

Total Exp Ratio

Revenue
Assets

Alternative Breakdown of ROA

Net Interest Income = NII = Int Inc Int Exp

Expense
Assets

Burden = Non IE Non II

Int Inc
TA

AU

Non Int Inc

TA

(some analysts include G/L in Non-interest income)

G/L
TA

ROA =
Int Exp
TA

EXP =

Non Int Exp

TA

PLL
TA

NII
TA

Burden
TA

PLL
TA

G/L
TA

TAX
TA

TAX
TA

81

Decomposition of ROE

82

Net Interest Income to TA Breakdown

NII
TA

ROE
x

ROA
AU

EM

Net Interest
Margin

PM

NII
Earning Assets

EA
TA

Earnings
Base

Net Int Income = Interest Income Interest Expense

AU

NII
TA

Burden
TA

Tot Exp

PLL
TA

G/L
TA

Net Interest
Margin

TAX
TA

83

Int Inc
EA

Int Exp
EA

84

14

Net Interest Income to TA Breakdown

Net Interest Margin and Spread

NII
TA

Int Inc
EA

EA
TA

) (

Yield on
Earning Assets

Int Exp
IBL

IBL
TA

Cost Rate on Interest

Bearing Liabilities

Net Interest
Margin

Int Inc
EA

Int Exp
EA

Spread

Int Inc
EA

Int Exp
IBL

Spread and NIM are important in evaluating a

banks ability to manage interest rate risk
As rates change, interest income and expense change
Variation in NIM and Spread indicate whether a bank
positioned itself to handle rate changes
Expected changes in NIM and Spread are examined to
access a banks exposure to interest rate risk
GAP and Earnings Sensitivity Analysis
86

85

Efficiency Ratio
Efficiency
Ratio

Putting It All Together

Ratios help you identify differences, examine
their origin, and ask the right questions to
determine if there is a problem

Non Int Exp

NII + Non Int Inc

Measures ability to control Non-Int Exp

Indicates
I di t how
h
much
h non-interest
i t
t expense a
bank has per dollar of operating income
The smaller the efficiency ratio, the more
profitable the bank, all other factors equal
Many analysts consider below 55% as
good on average
87

Peer and Trend Comparisons

Analysis: Move from general to specific

ROE is low Why?
Profit Margin is low Why?
Interest Expense/TA is high Why?
Is this a problem that needs to be
corrected?
Can go in opposite direction for forecasts

88

Avoiding Problems

Compare your ratios to those of your peers

Make decisions with goals in mind

Budgeting and planning built around model

Make sure you choose your peers carefully to

get a meaningful comparison
Be aware of differences in strategies that result
in differences between you and your peers

Short- and long-term objectives

Short- and long-term strategies
Respond to changes to create flexible
strategies

Compare your ratios this period to those for

previous periods

Quantify goals and examine results

How and why did ratios change?

Be aware of changes in strategy over time

Ratios can help give a quick summary of

expected performance
Are you headed in the direction you want?
89

90

15

Actual vs. Forecast/Budget

Relationships

Compare actual ratios to forecasted figures

Suppose IE/TA is high

Are we doing what we thought we would?

Why are there deviations?
Are changes necessary?

Heavier focus on acquiring demand and savings

deposits may help lower IE

Provides a control mechanism (and reality

check) that increases accountability
Do not look at any ratio in isolation
Change may solve one problem, but create
another or not be consistent with overall strategy
Consider interrelationships

However, additional processing costs and

demands on employees may increase noninterest expense
Which approach is less expensive?

91

92

Financial Statement Shortcomings

Risk Considerations

Off-balance sheet activities

Do not forget risk!

Derivative contracts may have massive notional

values that are not reflected in traditional
measures

Many times it is not difficult to increase

expected return.

Window dressing
g
Timing of asset/liability adjustments may impact
reported numbers

However, the additional return may come at

the cost of added risk.

Accounting Differences
Leeway in accounting reporting rules often make
comparisons difficult

Is the risk-return tradeoff reasonable?

93

94

ReturnonEquity

ReturnonAssets

20.00%

2.00%

15.00%

1.50%

10.00%

1.00%

<100M

<100M

100M<1B
5.00%

100M<1B
0.50%

1B<10B

1B<10B

>10B

0.00%

>10B

0.00%

5.00%

95

2009
2010

2008

2006
2007

2004
2005

2002
2003

2000
2001

1998
1999

1997

1995
1996

1993
1994

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

0.50%

96

16

EquityMultiplier

AssetUtilization
11.00%

15.00
14.00

10.00%

13.00
9.00%

12.00
11.00

<100M

10.00

100M<1B

<100M

8.00%

9.00

1B<10B

8.00

>10B

100M<1B

7.00%

1B<10B
6.00%

>10B

5.00%

7.00

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

4.00%

1993

6.00

97

98

IntInctoTA

ProfitMargin

9.00%

20.00%
8.00%

15.00%
7.00%

10.00%

<100M

<100M

5.00%

100M<1B
1B<10B

0.00%

6 00%
6.00%

100M<1B
1B<10B

5.00%

>10B

>10B
5.00%

4.00%

10.00%

2009
2010

2007
2008

2006

2004
2005

2002
2003

2001

1999
2000

1997
1998

1996

1994
1995

1993

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

3.00%

99

100

NetInterestMargin

InterestExpensetoTA

4.50%

4.00%
3.50%

4.00%

3.00%
2.50%
<100M
2 00%
2.00%

3.50%

<100M

100M<1B

1.50%

1B<10B

1.00%

>10B

100M<1B
3.00%

1B<10B
>10B

2.50%

0.50%
0.00%

101

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

2.00%

102

17

NonInterestExpensetoTA

NonIntInctoTA
4.50%

3.50%
3.00%

4.00%

2.50%
3.50%

<100M

2.00%

<100M
3.69%

100M<1B

1.50%

1B<10B
1.00%

>10B

3.00%

1B<10B
>10B

2.50%

0.50%

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1993

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1994

2.00%

0.00%

103

104

Gains/LossesonSecuritiestoTA

Burden
0.15%

3.00%

0.10%

2.50%

0.05%
0.00%

2.00%
1 50%
1.50%
1.00%

<100M

0.05%

<100M

100M<1B

0.10%

100M<1B

1B<10B

0.15%

>10B

0.20%

1B<10B
>10B

0.50%

0.25%

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1993

1994

0.30%

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

0.00%

105

106

ProvisionforLoanLossestoTA

LoanstoTA
75.00%

2.50%

70.00%

2.00%

65.00%
1.50%

<100M

<100M

100M<1B
1.00%

1B<10B

60 00%
60.00%

100M<1B
1B<10B

55.00%

1B<10B

0.50%

>10B
50.00%

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

45.00%

1993

0.00%

107

108

18

Review Questions
EfficiencyRatio
85.00%
80.00%
75.00%
<100M

70.00%

100M<1B

65.00%

A banks primary purpose is:

a. financial intermediation
b. investment banking
c. insurance sales
d. derivative trading

1B<10B
60.00%

>10B

55.00%

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

50.00%

109

Review Questions

110

Review Questions

Which of the following are found on a typical

banks balance sheet?
a. net interest income
b. net non-interest income
c. provision
i i ffor lloan llosses
d. investment securities

Which of the following are not found on a

typical banks balance sheet?
a. cash and due from banks
b. fed funds sold or purchased
c. non-interest
i t
t expense
d. deposits

111

Review Questions

Review Questions

Which of the following is the best description

of a banks balance sheet?
a. Cash & DFB + Securities + Loans + Other Assets
= Deposits + Purchased Liabilities + LT Debt +
Equity
b. Cash & DFB + Loans = Deposits + Equity
c. Cash & DFB + Securities + Loans + Deposits +
Other Assets = Purchased Liabilities + LT Debt +
Equity
d. Cash & DFB + LT Debt + Securities + Loans +
Other Assets = Deposits + Purchased Liabilities +
Equity

112

Which of the following are found on a typical

banks income statement?
a. cash and due from banks
b. fed funds
c. provision
i i ffor lloan llosses
d. deposits

113

114

19

Review Questions

Review Questions

Which of the following are found on a typical

banks income statement?
a. interest income
b. non-interest expense
c. provision
i i ffor lloan llosses
d. all of the above

Which of the following is the best description

of a banks net income from its income
statement?
a. interest income + non-interest income provision
gains/losses on securities taxes
for loan losses + g
b. interest income non-interest expense provision
for loan losses + gains/losses on securities taxes
c. interest income + burden provision for loan
losses + gains/losses on securities taxes
d. net interest income burden provision for loan
losses + gains/losses on securities taxes
115

Review Questions

116

Review Questions

Net interest income is calculated as:

a. noninterest income minus noninterest
expense
b. interest income minus interest expense
minus provision for loan losses
c. interest income minus interest expense
minus taxes
d. none of the above

The provision for loan losses:

a. is the account on the balance sheet indicating the
total funds available to cover bad loans
b. is the noncash expense on the income statement
representing funds put aside during the period to
prepare for bad loans
c. is the entry on the income statement that indicates
the realized gains and losses on securities
d. is the account on the balance sheet that indicates
the change in equity due to unrealized gains and
losses on securities
117

Review Questions

118

Review Questions

What is the purpose of financial analysis?

a. measure past performance
b. determine the starting point for planning and
estimate future performance
c. sett values
l
d. all of the above

119

Why do we use financial ratios to analyze

bank performance?
a. because financial ratios always tell the whole story
of performance
b. because financial statement data can never be
trusted
c. to standardize numbers and facilitate comparison
d. because financial ratios can be individually
analyzed without considering their relationship to
other ratios
120

20

Review Questions

Review Questions

The most common comparison norms for

financial ratios include:
a. past performance of the bank
b. other peer banks
c. both
b th a and
db
d. none of the above

A banks return on equity may be calculated

using its return on assets if we also know the
banks:
a. profit margin
b asset utilization
b.
c. equity multiplier or equity ratio
d. total expense ratio

121

122

Review Questions

Review Questions

A bank's equity multiplier reflects:

a. managements effectiveness in generating
revenue
b. managements effectiveness in controlling
expenses
c. the banks degree of financial leverage
d. none of the above

ROE
EM
ROA

2010
8.02%
7.71
1.04%

2009
7.69%
7.18
1.07%

2008
7.52%
6.71
1.12%

The primary reason the banks

bank s return on equity increased was
that:
a. the bank increased its income per dollar of assets
b. the bank decrease its income per dollar of assets
c. the bank increased its level of equity as a percentage of
total assets
d. the bank decreased its level of equity as a percentage of
total assets
123

Review Questions

124

Review Questions

A bank's asset-utilization ratio primarily

reflects:
a. the mix and yield on the bank's portfolio of
assets
b the mix and cost of the bank
b.
bank's
s source of
liabilities
c. the degree of operating risk the bank
assumes
d. the mix of debt and equity (equity multiplier)
the bank chooses
125

A bank's profit margin primarily reflects:

a. managements effectiveness in generating
revenue
b. managements effectiveness in controlling
expenses
c. the banks degree of financial leverage
d. none of the above

126

21

Review Questions

Review Questions

Other things constant, if the bank increases its

level of liabilities, its equity multiplier will:
a. increase
b. decrease
c. remain
i constant
t t
d. cannot be determined with given information

Other things constant, if the bank increases its

level of liabilities, its ROE will:
a. increase
b. decrease
c. remain
i constant
t t
d. cannot be determined with given information

127

Review Questions

Review Questions

Fill in the missing ROEs.

Suppose Net Income increases by 10% and

Average Equity increases by 15%. Will ROE:
a. increase
b. decrease
c. remain
i unchanged
h
d
d. cannot be determined with the given
information

Assets
divided by
q y
Equity

Return on Assets
0.5%

1.0%

1.5%

Return on Equity
10:1

128

5.0%

10.0%

15.0%

15:1
20:1
129

130

Review Questions

Review Questions

Suppose that from last year to this year, Net

Income for your bank increases by 20% and
Average Equity increases by 15%. How will
ROE change?
a ROE will increase
a.
b. ROE will decrease
c. ROE will not change
d. You cannot determine how ROE will change
based on this information

Bank A has a Profit Margin of 15% and Asset

Utilization of 10%. Bank B has a Profit
Margin of 12% and Asset Utilization of 12%.
Which bank has the higher ROA?
a Bank A
a.
b. Bank B
c. The ROAs for the two banks are identical
d. You cannot determine ROA based on the
given information

131

132

22

Review Questions

Review Questions

Which of the following would be explanations for why the banks

ROE declined from 2007 to 2008?
2008
2007
ROE 18.101%
18.333%
ROA 1.756%
1.601%
EM 10.308
11.453
AU
0.0960
0.0931
PM
18.292%
17.200%
a. the banks management generated less revenue per dollar of assets
b. the banks management did a poorer job of controlling expenses
c. the banks management used less financial leverage
d. all of the above are at least partial explanations of the decline in
ROE

Which of the following would help explain why the banks ROA
increased from 2007 to 2008?
2008
2007
ROE 18.101%
18.333%
ROA 1.756%
1.601%
EM 10.308
11.453
AU
0.0960
0.0931
PM
18.292%
17.200%
a. management generated more revenue per dollar of assets
b. management did a better job of controlling expenses
c. management used less financial leverage
d. a and b, but not c, help explain the increase in ROA

133

134

Review Questions

Review Questions

Holding all else constant, if a firm changes its

mix of demand deposit accounts and NOW
Accounts, this action will affect the:
a. yield on earning assets
b earnings base
b.
c. cost rate on interest bearing liabilities
d. equity multiplier

If a bank's yield on earning assets falls, one

can conclude that it pays too much for
deposits.
True
False

135

136

Review Questions

Review Questions

If we know that a banks yield on earning

assets has increased, we also know its net
interest margin has increased.
True
False

Calculate the banks ROA.

NII/TA
4.982%
Burden/TA
2.014%
PLL/TA
0.121%
GL/TA
G
/
0.030%
TAX/TA
0.442%
a. 2.678%
b. 2.436%
c. 2.376%
d. 3.561%
137

138

23

Review Questions

Review Questions

Suppose that a bank that has more stored

liquidity (cash and marketable securities)
than its peers, but that it is basically identical
to its peers in all other ways. This bank
p
would likelyy find that relative to its peers:
a. yield on earning assets is low.
b. cost rate on interest bearing liabilities is low.
c. yield on earning assets is high.
d. cost rate on interest bearing liabilities is
high.

A banks yield on earnings assets may be

impacted by:
a. changes in asset yields
b. changes in the relative mix of assets
c. both
b th a and
db
d. neither a nor b

139

140

Review Questions

Review Questions

A banks cost rate on interest bearing liabilities

is directly impacted by:
a. changes in asset yields
b. changes in the relative mix of assets
c. both
b th a and
db
d. neither a nor b

Burden measures:
a. the difference between interest income and
interest expense
b. the difference between non-interest
expense and non
non-interest
interest income
c. gains/losses on securities
d. taxes paid by the bank

141

Review Questions

142

Review Questions

A possible explanation for why a banks

burden ratio may be higher than its peers is:
a. the ratio of its personnel expense to total
assets is higher than its peers
b the ratio of its occupancy expense to total
b.
asset is lower than its peers
c. both a and b are possible explanations
d. neither a nor b are possible explanations

Financial ratios may not tell the whole story

about performance because of:
a. off-balance sheet activities
b. window dressing
c. accounting
ti diff
differences
d. all of the above

143

144

24