2. CHAPTER FIVE Measuring And Evaluating The Performance Of Banks And Their Principal Competitors The purpose of this chapter is to discover what analytical tools can be applied to a bank’s financial statements so that management and the public can identify the most critical problems inside each bank and develop ways to deal with those problems

3. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-3 Value of the Bank’s Stock

4. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-4 Value of a Bank’s Stock Rises When: Expected Dividends Increase Risk of the Bank Falls Combination of Expected Dividend Increase and Risk Decline

5. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-5 Value of Bank’s Stock if Earnings Growth is Constant

6. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-6 Key Profitability Ratios in Banking

7. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-7 Key Profitability Ratios in Banking (cont.)

8. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-8 Breaking Down ROE x x

9. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-9 ROE Depends On: Equity Multiplier Leverage or Financing Policies Net Profit Margin Effectiveness of Expense Management Asset Utilization Portfolio Management Policies

10. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-10 Components of ROE for All Insured U.S. Banks (1991-2002)

11. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-11 Bank Risks Credit Risk Liquidity Risk Market Risk Interest Rate Risk Earnings Risk Capital Risk

12. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-12 Credit Risk The Probability that Some of the Bank’s Assets Will Decline in Value and Perhaps Become Worthless

13. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-13 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

14. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-14 Liquidity Risk Probability the Bank Will Not Have Sufficient Cash and Borrowing Capacity to Meet Deposit Withdrawals and Other Cash Needs

15. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-15 Liquidity Risk Measures Purchased Funds/Total Assets Net Loans/Total Assets Cash and Due from Banks/Total Assets Cash and Government Securities/Total Assets

16. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-16 Market Risk Probability of the Market Value of the Bank’s Investment Portfolio Declining in Value Due to a Rise in Interest Rates

17. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-17 Market Risk Measures Book-Value of Assets/ Market Value of Assets Book-Value of Equity/ Market Value of Equity Book-Value of Bonds/Market Value of Bonds Market Value of Preferred Stock and Common Stock

18. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-18 Interest Rate Risk The Danger that Shifting Interest Rates May Adversely Affect a Bank’s Net Income, the Value of its Assets or Equity

19. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-19 Interest Rate Risk Measures Interest Sensitive Assets/Interest Sensitive Liabilities Uninsured Deposits/Total Deposits

20. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-20 Earnings Risk The Risk to the Bank’s Bottom Line – Its Net Income After All Expenses

21. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-21 Earnings Risk Measures Standard Deviation of Net Income Standard Deviation of ROE Standard Deviation of ROA

22. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-22 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

23. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-23 Capital Risk Measures Stock Price/Earnings Per Share Equity Capital/Total Assets Purchased Funds/Total Liabilities Equity Capital/Risk Assets

24. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-24 Other Forms of Risk in Banking Inflation Risk Currency or Exchange Rate Risk Political Risk Crime Risk

25. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-25 Bank Performance Indicators Related to Size 2002

26. McGraw-Hill/Irwin Bank Management and Financial Services, 6/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-26 UBPR The Uniform Bank Performance Report Provided by U.S. Federal Regulators so that Analysts Can Compare the Performance of One Bank Against Another