Some Definitions

1
Some Definitions

• Averages
• Often, we will look at quarterly averages for
  asset accounts computing averages
• See FDIC performance calculations

2
Some Definitions

• Total operating revenue
• Total Interest Income Total Non-Interest Income
• Total operating expenses
• Total Interest Expense Total Non-Interest
  Expense - Securities Gain(Loss) Taxes

3
Some Definitions

• Total earning assets
• Interest earning balances (from other depository
  institutions) securities fed funds sold and
  reverse repurchase agreements net loans and
  leases non-derivative trading assets
• Total interest bearing liabilities
• Interest bearing deposits fed funds purchased
  and repurchase agreements non-derivative
  trading liabilities other borrowed funds
  subordinated notes and debentures

4
Key Profitability Ratios in Banking
5
Key Profitability Ratios in Banking (cont.)
Total Interest Income __ Total
Interest Expense Earnings Spread Total Earning
Assets Total Interest Bearing Liability
6
Breaking Down ROE
x
x
7
Another way to view ROE

• ROE AU ER TAX
• AU asset utilization total revenue / TA
• ER operating expense ratio expenses /TA
• TAX taxes taxes/TA

8
Breaking down expense ratio

• ER expenses / TA
• What are expenses?
• Interest expenses (IE), non-interest expenses
  (NIE), provisions for loan losses (PLL)
• Thus, ER IE/TA NIE/TA PLL/TA

9
Breaking down asset utilization ratio

• AU total revenue / TA
• What is total revenue?
• Interest income (II), non-interest income (NII),
  security gains/losses (SG)
• Thus, AU II/TA NII/TA SG/TA

10
Bank Risks

• Credit Risk
• Liquidity Risk
• Market Risk
• Interest Rate Risk
• Operational Risk

• Legal and Compliance Risk
• Reputation Risk
• Strategic Risk
• Capital Risk

11
Credit Risk

• The Probability that Some of the Financial
  Firms Assets Will Decline in Value and Perhaps
  Become Worthless

12
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
• Nonperforming Loans/Equity Capital

13
Liquidity Risk

• Probability the Financial Firm Will Not Have
  Sufficient Cash and Borrowing Capacity to Meet
  Deposit Withdrawals and Other Cash Needs

14
Liquidity Risk Measures

• Purchased Funds/Total Assets
• Net Loans/Total Assets
• Cash and Due from Banks/Total Assets
• Cash and Government Securities/Total Assets

15
Market Risk

• Probability of the Market Value of the Financial
  Firms Investment Portfolio Declining in Value
  Due to a Change in Interest Rates

16
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

17
Interest Rate Risk

• The Danger that Shifting Interest Rates May
  Adversely Affect a Banks Net Income, the Value
  of its Assets or Equity

18
Interest Rate Risk Measures

• Interest Sensitive Assets/Interest Sensitive
  Liabilities
• Uninsured Deposits/Total Deposits

19
Operational Risk

• Uncertainty Regarding a Financial Firms Earnings
  Due to Failures in Computer Systems, Errors,
  Misconduct by Employees, Floods, Lightening
  Strikes and Similar Events or Risk of Loss Due to
  Unexpected Operating Expenses

20
Legal and Compliance Risk

• Risk of Earnings Resulting from Actions Taken by
  the Legal System. This can Include Unenforceable
  Contracts, Lawsuits or Adverse Judgments.
  Compliance Risk Includes Violations of Rules and
  Regulations

21
Reputation Risk

• This is Risk Due to Negative Publicity that can
  Dissuade Customers from Using the Services of the
  Financial Firm. It is the Risk Associated with
  Public Opinion.

22
Capital Risk

• Probability of the Value of the Banks Assets
  Declining Below the Level of its Total
  Liabilities. The Probability of the Banks Long
  Run Survival

23
Capital Risk Measures

• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets

24
Other Goals in Banking