Tài chính doanh nghiệp - Chapter 20: Bank performance

Chapter 20Bank PerformanceFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineValuation of a commercial bankPerformance evaluation of banksRisk evaluation of banksHow to evaluate a bank’s performanceBank failures2Valuation of a Commercial BankThe value of a commercial bank is the present value of its future cash flows:The value should change in response to changes in its expected cash flows and to changes in the required rate of return:3Valuation of a Commercial Bank (cont’d)Factors that affect cash flowsChange in economic growthDuring periods of strong economic growth:Loan demand is higherCommercial banks provide more loansDemand for other bank products tends to be higherFewer loan defaults occurExpected cash flows should be higher4Valuation of a Commercial Bank (cont’d)Factors that affect cash flows (cont’d)Change in the risk-free interest rateIf the risk-free rate decreases and other market rates decline, there may be stronger demand for the bank’s loansBanks’ cost of funds decreases when the risk-free rate decreasesChange in industry conditionsIf regulators reduce the constraints imposed on commercial banks, expected cash flows should increaseTechnical innovation can improve efficiencies and enhance cash flowsA high level of competition may reduce the bank’s volume of business or reduce the prices it can charge for its services5Valuation of a Commercial Bank (cont’d)Factors that affect cash flows (cont’d)Change in management abilitiesManagers can attempt to make internal decisions that will capitalize on the external forces that the bank cannot controlSkillful managers will recognize how to revise the composition of the bank’s assets and liabilities to capitalize on existing economic or regulatory conditions6Valuation of a Commercial Bank (cont’d)Factors that affect the required rate of return by investorsChange in the risk-free rateWhen the risk-free rate increases, so does the return required by investors:7Valuation of a Commercial Bank (cont’d)Factors that affect the required rate of return by investors (cont’d)Change in the risk premiumWhen the risk premium increases, so does the return required by investors:Impact of the September 11 Crisis on commercial bank valuesCommercial bank valuations declined as a result because economic conditions were weakened and the volume of bank loans declined8Performance Evaluation of BanksIn the recessions of 1982, the early 1990s, and the early 2000s, banks were adversely affectedThe international debt crisis of the 1980s had a major impact on the largest banks with loans to less developed countries9Performance Evaluation of Banks (cont’d)Interest income and expensesGross interest income is interest income generated from all assetsAffected by market rates and the composition of assets held by banksGross interest income on small and medium banks is typically higher than that of other banksGross interest expenses represent interest paid on deposit and on other borrowed fundsAffected by market rates and the composition of the bank’s liabilitiesIn recent years, gross interest expenses have been similar among banks10Performance Evaluation of Banks (cont’d)Interest income and expenses (cont’d)Net interest income is the difference between gross interest income and interest expenses and is measured as a percentage of assetsThe net interest margin of all banks in aggregate has remained somewhat stableNet interest margin has generally been highest for the small banks and lowest for money center banks11Performance Evaluation of Banks (cont’d)Noninterest income and expensesNoninterest income results from fees charged on services providedHas consistently risen over time for all banks in aggregateUsually higher for money center, large, and medium banks than for small banks because larger banks provide more servicesThe loan loss provision is a reserve account established in anticipation of future loan lossesShould increase in recessionary periodsWas high for most banks during the early 1990s recession but declined for the next several years12Performance Evaluation of Banks (cont’d)Noninterest income and expenses (cont’d)Noninterest expenses include salaries, office equipment, and other expensesGenerally increased over timeSecurities gains and losses result from a bank’s sale of securitiesHave been negligible in the aggregateIncome before tax is obtained by summing net interest income, noninterest income, and securities gains and subtracting the provision for loan losses and noninterest expensesIn recent years, bank income was enhanced by the increase in noninterest income and in net interest margins13Performance Evaluation of Banks (cont’d)Net incomeNet income accounts for any taxes paidReturn on assets (ROA):Is net income measured as a percentage of assetsHas been unusually high in recent years because of the increase in noninterest incomeHas been high for medium and large banks recentlyDepends on the bank’s policy decisions as well as uncontrollable factors relating to the economy and government regulations14Performance Evaluation of Banks (cont’d)Net income (cont’d)Return on equity (ROE)ROE is affected by the same income statement items that affect ROA as well as the bank’s degree of financial leverage:The leverage measure is the inverse of the capital ratioIn recent years, money center banks have experienced a lower ROE than other banks because of their low ROA and high degree of capital15Risk Evaluation of BanksNo consensus measurement of risk exists that allows for comparison of various types of risk among all banksBeta is the degree of sensitivity of stock returns to the returns of the stock market as a whole:The regression model is applied to quarterly historical dataThe coefficient is an estimate of beta because it measures the sensitivity of bank returns to market returnsBanks whose stock returns are less vulnerable to economic conditions have relatively low betasBeta ignores unsystematic risk16How to Evaluate a Bank’s PerformanceAnalysts often need to evaluate an individual bank’s performanceExamination of return on assetsROA usually reveals when a bank’s performance is not up to parThe components of ROA must be evaluated separately to determine the reason (see next slide)17How to Evaluate a Bank’s Performance (cont’d)Measures of Bank PerformanceFinancial Characteristics Influencing PerformanceBank Decisions Affecting Financial CharacteristicsReturn on assets (ROA)Net interest marginDeposit rate decisionsLoan rate decisionsLoan lossesNoninterest revenuesBank services offeredNoninterest expensesOverhead requirementsEfficiencyAdvertisingLoan lossesRisk level of loans providedReturn on equity (ROE)ROASee aboveLeverage measureCapital structure decision18Bank FailuresFrom 1940 to 1980, there were generally fewer than 20 bank failures per yearIn the late 1980s, there were about 200 failures per yearFailures declined in the early 1990sIn the mid and late 1990s, the number of bank failures declined substantially19Bank Failures (cont’d)Reasons for bank failureThe bank may have experienced fraudIncludes embezzlement of fundsThe bank may have a high loan default percentageNo matter how well a bank diversifies its loans, it is still subject to a recessionary cycleThe bank may experience a liquidity crisisRumors may cause depositors to withdraw funds and the bank may be unable to attract new depositsThe bank may face increased competitionDeregulation has made the banking industry more competitiveA reduced net interest margin could lead to failure20Bank Failures (cont’d)Reasons for bank failure (cont’d)The Office of the Comptroller of the Currency reviewed 162 national failed banks since 1979 and found the following common characteristics:81 percent of the banks did not have a loan policy or did not closely follow their loan policy59 percent of the banks did not use an adequate system for identifying problem loans63 percent of the banks did not adequately monitor key bank officers or departments57 percent of the banks allowed one individual to make major corporate decisions21