Professional Documents
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Chapter 3 Analyzing Bank Performance
Chapter 3 Analyzing Bank Performance
Performance
1
Analyzing Bank Performance
In 2008, depository institutions
reported:
Worsening asset quality leading to
higher charge-offs
Shrinking net interest income
Declining non-interest income
These factors led to lower profits, ROE,
ROA, and bank failures
2
3
Analyzing Bank Performance
Depository Institution Failures
Over 1,500 bank failures between 1985
and 1993
0 in 2005 or 2006
3 in 2007
Sharp increase in 2008 and 2009
26 in 2008
4
Commercial Bank Financial
Statements
Most depository financial institutions
own few fixed assets and thus exhibit
low operating leverage
Many bank liabilities carry short-term
maturities. As a result, interest
expense changes coincidentally with
short-run changes in market interest
rates
5
Commercial Bank Financial
Statements
Many commercial bank deposits are
insured by the FDIC. Insured deposits
carry below-market interest rates
Banks operate with less equity capital
than non-financial companies, which
increases financial leverage and the
volatility of earnings
6
Commercial Bank Financial
Statements
Bank Assets
Loans
Real Estate
Commercial
Individual
Agricultural
7
Commercial Bank Financial
Statements
Bank Assets
Adjustment to Loans
Gross Loans and Leases
minus
Unearned Income
Loan and Lease Loss (Allowance for
8
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Short-Term Investments
One year or less
Examples:
Interest-Bearing Deposits Due from
Other Banks
Fed Funds Sold
Reverse Repos
T-Bills
9
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Long-Term Investments
Over one year
Examples:
T-Notes and T-Bonds
Government Agency Issues
Foreign and Corporate Bonds
Mortgage-Backed Securities
Municipal Securities: General Obligation
Municipal Securities: Revenue
10
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Held-to-Maturity
Trading Account
Available-for-Sale
11
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Held-to-Maturity
Intent and ability to hold until maturity
Recorded at cost (Book Value)
Changes in value (unrealized gains or
losses) are NOT reflected on the balance
sheet or income statement
May be a current or long-term asset,
depending on maturity
12
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Trading Account
Objective is to generate trading profits
Marked-to-Market
Changes in value (unrealized gains and
losses) ARE reflected on the Income
Statement
Always a current asset, regardless of
maturity of the underlying security
13
Commercial Bank Financial
Statements
Bank Assets
Investment Securities
Available-for-Sale
For those securities that do not fall into the
HTM or
Trading categories
Market-to-Market
Change in value (unrealized gains or losses)
ARE reflected on the Balance Sheet (Change to
Shareholder’s Equity)
May be a current or long-term asset, depending
on maturity
14
Commercial Bank Financial
Statements
Bank Assets
Non-Interest Cash and Due From
Banks
Vault Cash
Deposits held at the Federal Reserve
(CIPC)
Largest component of this category
15
Commercial Bank Financial
Statements
Bank Assets
Other Assets
Bank Premises
OREO
16
17
18
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s Equity
Transaction Accounts
Demand Deposits
Pays no interest
Available to all customers
NOW Accounts
Pays “market” interest rate
Not available to for-profit corporations
ATS Accounts
Pays “market” interest rate
Not available to for-profit corporations
19
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
Transaction Accounts
MMDAs
Pays market interest rate
Limited to six checks per month
Available to all customers
20
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
Savings and Time Deposits
Savings Deposits
No Maturity
Time Deposits (CDs)
“Large” or Jumbo CDs
Negotiable
“Small” CDs
21
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
Other Borrowings
Fed Funds Purchased Repurchase
Agreements
Brokered Deposits
22
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s Equity
Core Deposits
Deposits that are NOT very interest rate
sensitive
Represent permanent funding base
Made up of:
Demand Deposits
NOW and ATS accounts
MMDAs
Savings Accounts
“Small” Time Deposits
23
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
Non-Core Deposits
Deposits that are very interest rate
sensitive
AKA
Volatile Liabilities
Hot Money
Purchased Liabilities
Short-Term Non-Core Funding
24
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
Non-Core Deposits
Consist of:
Federal Funds Purchased
Repos
“Large” Time Deposits
Brokered Time Deposits
25
Commercial Bank Financial
Statements
Bank Liabilities and Stockholder’s
Equity
All Common and Preferred Equity
Preferred Stock
Common Stock
26
27
28
29
Commercial Bank Financial
Statements
Income Statement
Interest Income (II)
Includes interest and fees from:
Loans
Deposits at other institutions
Trading Account Securities
Municipal Securities
Estimated Tax Benefit =
Municipal Interest Rate/(1 – Marginal Tax
Rate) = Tax-Equivalent Municipal Interest
Income
30
Commercial Bank Financial
Statements
Income Statement
Interest Expense (IE)
Includes interest paid on all interest-
bearing liabilities:
NOW Accounts
ATS Accounts
MMDAs
Savings Accounts
Time Deposits
Non-Core Liabilities
Long-Term Debt 31
Commercial Bank Financial
Statements
Income Statement
Interest Income (II)
minus
32
Commercial Bank Financial
Statements
Income Statement
Non-Interest Income (OI)
Includes:
Personnel
Occupancy
Technology
Utilities
Deposit Insurance Premiums
Intangible Amortizations
Goodwill Imparement
34
Commercial Bank Financial
Statements
Income Statement
Non-Interest Expense (OE)
minus
Burden
Non-interest expense is typically larger
profitability 35
Commercial Bank Financial
Statements
Income Statement
Provision for Loan and Lease Losses (PLL)
Estimate of potential losses on loans
Relationship between PLL and ALL
37
Commercial Bank Financial
Statements
Income Statement
Net Interest Income (NII)
minus
Burden
minus
PLL
plus
38
Commercial Bank Financial
Statements
Income Statement
Pre-Tax Net Operating Income (te)
minus
Taxes (T)
minus
Extraordinary Items
equals
39
Commercial Bank Financial
Statements
Income Statement
Total Revenue (TR) or Total Operating
Income (TOI)
Includes:
Interest Income
Non-Interest Income
Realized Security Gains (Losses)
Analogous to Net Sales
40
Commercial Bank Financial
Statements
Income Statement
Total Operating Expense (EXP)
Includes
Interest Expense
Non-Interest Expense
PLL
Analogous to COGS + Operating
Expenses
41
Commercial Bank Financial
Statements
Income Statement
NI = NII – Burden – PLL + SG – T
42
Relationship Between Balance
Sheet & Income Statement
Ai = Dollar magnitude of the ith asset
Lj = Dollar magnitude of the jth liability
NW = Dollar magnitude of equity
yi = Average pre-tax yield on the ith
asset
cj = Average pre-tax cost on the jth
liability
43
Relationship Between Balance
Sheet & Income Statement
n m
A L
i 1
i
j 1
j NW
n
Interest Income yi Ai
i 1
m
Interest Expense c j L j
i 1
44
Relationship Between Balance
Sheet & Income Statement
Net Interest Income
Changes with changes in:
Composition
Volume
n m
Net Interest Income yi Ai c j L j
i 1 i 1
n m
Net Income yi Ai c j L j Burden - P LL SG - T
i 1 i 1
45
Return on Equity Model
Profitability Analysis
Return on Equity (ROE)
Return on Assets (ROA)
46
Return on Equity Model
Profitability Analysis
Return on Equity
Net Income/Average Total Equity
ROA x EM
47
Return on Equity Model
Expense Ratio and Asset Utilization
Asset Utilization (AU)
Total Revenue/Average Total Assets
TR/aTA
Expense Ratio (ER)
Total Operating Expenses/Average
Total Assets
EXP/aTA
Tax Ratio (TAX)
Taxes/Average Total Assets
48
Return on Equity Model
Expense Ratio and Asset Utilization
Net Income/Average Total Assets
NI TR EXP Taxes
ROA
aTA aTA aTA aTA
ROA = AU – ER – TAX
49
Return on Equity Model
Expense Ratio and Asset Utilization
Expense Ratio (ER)
Total Operating Expense/Average Total
Assets
EXP/aTA
EXP IE OE PLL
ER
aTA aTA aTA aTA
50
Return on Equity Model
Expense Ratio and Asset Utilization
Expense Ratio (ER)
IE can change due to changes in:
Volume
Different levels of liabilities versus
equity
Composition
Different mix of liabilities
Rates
EXP IE OE PLL
ER
aTA aTA aTA aTA 51
Return on Equity Model
Expense Ratio (ER)
Non-Interest Expense
Personnel Expenses
Occupancy Expenses
Technology Expenses
Other Overhead Expenses
EXP IE OE PLL
ER
aTA aTA aTA aTA
52
Return on Equity Model
Income: Asset Utilization Components
Total Revenue
Includes:
TR II OI SG
AU
aTA aTA aTA aTA
53
Return on Equity Model
Income: Asset Utilization Components
II can change due to changes in:
Volume
Fees
Trust Activities
Service Charges
Other Non-Interest Income
TR II OI SG
AU
aTA aTA aTA aTA
55
Return on Equity Model
Aggregate Profitability Measures
Net Interest Margin (NIM)
Net Interest Income/Average Earning
Assets
Spread
Interest Income/Average Earning
56
Return on Equity Model
Aggregate Profitability Measures
Burden
(Non-Interest Expense – Non-Interest
57
58
Managing Risks and Returns
Risk Management
Credit Risk
Liquidity Risk
Market Risk
Operational Risk
Reputation Risk
Legal Risk
59
Managing Risks and Returns
Risk Management
Credit Risk
Historical Loss Rate
60
Managing Risks and Returns
Risk Management
Credit Risk
Expected Future Losses
Past-Due Loans
Interest and Principal has not been paid but it
is still accruing interest
30-89 days
90 days and over
Non-Performing Loans
90 days or more past-due
Non-Accrual Loans
Not accruing interest
61
Managing Risks and Returns
Risk Management
Credit Risk
Expected Future Losses
62
Managing Risks and Returns
Risk Management
Credit Risk
Preparation for Losses
63
Managing Risks and Returns
Risk Management
Credit Risk
Preparation for Losses
Lack of Diversification
High Loan Growth
Country Risk
64
Managing Risks and Returns
Risk Management
Liquidity Risk
Funding Liquidity Risk
65
Managing Risks and Returns
Risk Management
Liquidity Risk
Holding Liquid Assets
Pledging Requirements
Cash Assets
Not a good source of liquidity for a bank
Ability to Borrow for Liquidity
Volatile Liabilities
“Hot Money” versus Core Deposits
Large CDs
Fed Funds Purchased
Repos
66
Managing Risks and Returns
Risk Management
Market Risk
Interest Rate Risk
68
Managing Risks and Returns
Risk Management
Operational Risk
Business Interruptions
Transaction Processing
Client Liability
Legal Risk
Reputation Risk
69
Managing Risks and Returns
Risk Management
Capital or Solvency Risk
Risk of becoming insolvent
70
Evaluating Bank Performance:
An Application
Profitability Analysis for PNC in 2007
71
72
73
74
75
76
Maximizing the Market Value of
Bank Equity
Effective Management of:
Assets
Liabilities
Off-Balance Sheet Activities
Interest Rate Margin
Credit risk
Liquidity
Non-Interest Expense
Taxes
77
Maximizing the Market Value of
Bank Equity
CAMELS Ratings
Capital Adequacy
Asset Quality
Management Quality
Earnings
Liquidity
Sensitivity to Market Risk
78
Maximizing the Market Value of
Bank Equity
CAMELS Ratings
Ratings from 1 (best) to 5 (worst)
1 & 2
Sound banks
3
Some underlying problems
4&5
Problem banks
79
80
Maximizing the Market Value of
Bank Equity
Performance Characteristics of Banks
by Size
Large Banks versus Small Banks
Higher ROE
Lower NIM
Higher Charge-offs
Lower Capital
81
82
Financial Statement Manipulation
Off-Balance Sheet Activities
Window Dressing
Preferred Stock
Non-Performing Loans
Allowance for Loan Losses
Securities Gains and Losses
Non-Recurring Extraordinary Items
83
Analyzing Bank
Performance
84