The Business of Banking. Bank Performance Analysis

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Cuthbert Robinson
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1 The Business of Banking Bank Performance Analysis

2 Objectives Explain the ratios used in analyzing the performance of a commercial bank Calculate the various performance ratios to evaluate the performance of a commercial bank Recognize the historical experience of the commercial banking industry Explain the various driver ratios used to explain bank management strategies

3 Analyzing Performance System that decomposes changes in ROA/ROE Identifies drivers of profitability performance Illustrates connection between drivers and final performance results Useful at all levels of performance analysis Industry Bank Line of business

4 Return on Assets Return on Assets ROA = Net Income Total Assets 1.25 percent is good performance Overall: entire industry strong through and 2008 are meltdown years Medium sized banks leading pack, but fell hardest Small banks having hard time recovering (0.75%)

5 Performance Results: ROA <100M 100M<1B 1B<10B >10B 2.0% 1.5% 1.0% 0.5% 0.0% -0.5%

6 Return on Equity Return on Equity ROE = Net Income Equity Large banks near top Industry trend flat (to lower) before 2008 How can ROA trend upward and ROE trend flat to downward? Negative for many banks in 2008 Small banks consistently lower

7 Performance Results: ROE <100M 100M<1B 1B<10B >10B 18% 14% 10% 6% 2% -2% -6%

8 What Drives ROA and ROE? Interest Rate Factors Yield on Earning Assets Cost Rate on Interest Bearing Liabilities Quality of Assets Operational Factors Non-Interest Income Non-Interest Expense

9 Performance Driver Ratios Yield on Earning Assets Yield on Earning Assets = Total Interest Income Earning Assets Most banks are tightly bunched together Large banks are below industry Smaller banks are leading industry Note how yields move with changes in interest rates

10 Yield on Earning Assets <100M 100M<1B 1B<10B >10B 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0%

11 Performance Driver Ratios Cost Rate on Interest Bearing Liabilities Total Interest Expense Cost Rate on IBL = Interest Bearing Liabilities Large banks paid more in 90s More purchased money, less core deposits Negotiable CDs, Eurodollar CDs, Fed Funds Other groups are now following suit All banks are close together

12 Cost Rate on IBL <100M 100M<1B 1B<10B >10B 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%

13 Yield versus Cost Rate (Spread) 10.0% <100M 100M<1B 1B<10B >10B <100M 100M<1B 1B<10B >10B 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%

14 Performance Driver Ratios Net Interest Margin Net Interest Margin = Net Interest Income Earning Assets Large banks have lower Net Int. Margin Lower yield on EA, higher cost rate on IBL Very hard to grow and maintain high NIMs Overall trend is downward But no cataclysmic decrease in 2008

15 Net Interest Margin <100M 100M<1B 1B<10B >10B 5.0% 4.5% 4.0% 3.5% 3.0% 2.5%

16 Performance Driver Ratios Loan Loss Provision to Earning Assets Loan Loss Provision to EA = Loan Loss Provision Earning Assets Industry was very clean Quality of loans, economic expansion Until late 2006/early 2007 Early 2000 s Recession was short-lived Many banks with negative provisioning in 04, 05, and 06 Recession problems in 2007/2008

17 Loan Loss Provision to EA <100M 100M<1B 1B<10B >10B 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

18 Performance Driver Ratios Non-Interest Income to EA Non-Interest Income to EA = Non-Interest Income Earning Assets Steady increase in industry in 1990 s Nondeposit fee income Gains in trading income But gains have not continued in 2000s

19 Non-Interest Income to EA <100M 100M<1B 1B<10B >10B 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

20 Performance Driver Ratios Non-Interest Expense to EA Non-Interest Expense to EA = Non-Interest Expense Earning Assets Industry has been stable, downward trend Larger banks are lowest Non-interest burden is decreasing But gains are on expense side rather than income side need to focus on revenue Meltdown did not see dramatic effect

21 Non-Interest Expense to EA <100M 100M<1B 1B<10B >10B 5.0% 4.5% 4.0% 3.5% 3.0% 2.5%

22 Burden = Non-Int Exp less Non-Int Inc 3.5% <100M 100M<1B 1B<10B >10B 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

23 Performance Driver Ratios Efficiency Ratio Efficiency Ratio = Non-Interest Expense Net Int Income + Non-Int Income Not a decomposition driver, but an important metric in managing bank efficiency. Measures the cost of producing a dollar of revenue net of financing cost. Meltdown sees big increase due to decreased revenue streams, but largest cut costs

24 Efficiency Ratio <100M 100M<1B 1B<10B >10B 85% 80% 75% 70% 65% 60% 55% 50%

25 Gain/Loss on Asset Sales to EA Gain/Loss on Asset Sales to EA Gain/Loss on Asset Sales Earning Assets Can have a significant impact on individual banks Industry numbers are too small to view in a graph

26 Performance Relationships Yield on EA - Cost Rate on IBL Net Interest Margin (actually spread) - Loan Loss Provision to EA + Non-Interest Income to EA - Non-Interest Expense to EA + Gain/Loss on Transactions to EA

27 Performance Results: ROA revisited <100M 100M<1B 1B<10B >10B 2.0% 1.5% 1.0% 0.5% 0.0% -0.5%

28 Performance Results: ROE revisited <100M 100M<1B 1B<10B >10B 18% 14% 10% 6% 2% -2% -6%

29 Relationship of ROA and ROE How can ROA trend upward and ROE trend flat to downward? ROE = ROA x Total Assets Equity The amount of leverage, or equity financing, is the key variable.

30 Strategic Relationship Eq/TA TA/Eq x ROA = ROE 5.00% 20.0x 1.50% 30.0% 6.00% 16.7x 1.50% 25.0% 7.00% 14.3x 1.50% 21.4% 8.00% 12.5x 1.50% 18.8% The amount of leverage, or equity financing, is the key variable.

31 Equity to Total Assets <100M 100M<1B 1B<10B >10B 14% 13% 12% 11% 10% 9% 8% 7% 6%

32 Performance Analysis The analysis that we have just completed can be arrayed in a strategic relationship Any change in the drivers will cause a change in results variables (ROA and ROE) Strategic initiatives should be designed to cause specific changes in the drivers Actual calculations can be done on the basis of total assets rather than earning assets

33 Decomposing ROE Tree Net Int. Margin - LLP/EA +NII/EA - NIX/EA + Gain or Loss to EA = Pretax Return on EA * EA/TA - Income Taxes = ROA * TA/Eq = ROE

34 Performance Summary Industry ROA and ROE recovering last couple of years Net interest margin has been declining Lower loan loss provisions Pressure on non-interest income Non-interest expense leveling out to up

35 Decisions Affecting ROE Pricing and mix of assets Pricing and mix of liabilities Quality and growth of loans Service charges and fee income Expense control Choice to sell assets Amount of earning assets Ability to manage taxes Payment of dividends Use of deposits and debt

36 Data Sources Comparative Data Sources FDIC Statistics on Depository Institutions (SDI) Similar data can also be obtained from the FDIC via www5.fdic.gov/qbp and www5.fdic.gov/sdi/sob Industry definitions SDI offers several predefined peer groups: <100M, 100M to 300M, 300M to 500M, 500M to 1B, 100M to 1B, 1B to 10B, and >10B Custom peer groups may also be defined by the user

Bank Assets BANK FINANCIAL STATEMENTS. The Balance Sheet Conceptually. Bank Securities. Types of Loans. Balance Sheet Deposits. Cash & Due from Banks

Bank Assets BANK FINANCIAL STATEMENTS. The Balance Sheet Conceptually. Bank Securities. Types of Loans. Balance Sheet Deposits. Cash & Due from Banks BANK FINANCIAL STEMENTS Bank Assets Cash and due from banks Vault cash, deposits held at the Fed and other financial institutions, and cash items in the process of collection Investment Securities Bonds,