Chapter 4 - Measuring and Evaluating the Performance of Banks

CHAPTER 4

MEASURING AND EVALUATING THE PERFORMANCE OF BANKS

1. Suppose that a bank is expected to pay an annual dividend of $4 per share on its stock in the
current period and dividends are expected to grow 5 percent a year every year, and the minimum
required return-to-equity capital based on the bank's perceived level of risk is 10 percent. Can
you estimate the current value of the bank's stock?

2. Suppose a bank reports that its net income for the current year is $51 million, its assets total
$1,144 million, and its liabilities amount to $926 million. What is its return on equity capital? Is
the ROE you have calculated good or bad?

3. A bank estimates that its total revenues will amount to $155 million and its total expenses
(including taxes) will equal $107 million this year. Its liabilities total $4,960 million while its
equity capital amounts to $52 million. What is the bank's return on assets? Is this ROA high or
low? The bank's return on assets would be:

4. Suppose a banker tells you that his bank in the year just completed had total interest expenses
on all borrowings of $12 million and noninterest expense of $5 million, while interest income
from earning assets totaled $16 million and noninterest revenues totaled $2 million. Suppose
further that assets amounted to $480 million, of which earning assets represented 85 percent of
that total while total interest-bearing liabilities amounted to 75 percent of total assets. See if you
can determine this bank's net interest and noninterest margins and its earnings spread for the
most recent year.

5. Suppose a bank has an ROA of 0.80 percent and an equity multiplier of 12X. What is its
ROE? Suppose this bank's ROA falls to 0.60 percent. What size equity multiplier must it have to
hold its ROE unchanged?

6. Suppose a bank reports net income of $12, pre-tax net income of $15, operating revenues of
$100, assets of $600, and $50 in equity capital. What is the bank's ROE? Asset management
efficiency indicator? Funds management efficiency indicator?

7. If a bank has a net interest margin of 2.50%, a noninterest margin of -1.85%, and a ratio of
provision for loan losses, taxes, security gains, and extraordinary items of -0.47%, what is its
ROA?

8. An investor holds the stock of Foremost Financials and expects to receive a dividend of $5.75
per share at the end of the year. Stock analysts recently predicted that the bank’s dividends will
grow at approximately 3 percent a year indefinitely into the future. If this is true, and if the
appropriate risk-adjusted cost of capital (discount rate) for the bank is 12.25 percent, what should
be the current price per share of Foremost Financials’ stock?

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Chapter 4 - Measuring and Evaluating the Performance of Banks

9. Suppose that stockbrokers have projected that Yorktown Savings will pay a dividend of $3 per
share on its common stock at the end of the year; a dividend of $4.50 per share is expected for
the next year, and $ 5.50 per share in the following two year. The cost of capital for banks in
Yorktown’s risk class is 15 percent. If an investor holding Yorktown’s stock plans to hold that
stock for only four years and hopes to sell it at a price of $60 per share, what should the value of
the bank’s stock be in today’s market?

10. Bluebird Savings Association has a ratio of equity capital to total assets of 9 percent. In
contrast, Cardinal Savings reports an equity-capital-to- asset ratio of 7 percent. What is the value
of the equity multiplier for each of these institutions? Suppose that both institutions have an
ROA of 0.85 percent. What must each institution’s return on equity capital be?

11. The latest report of condition and income and expense statement for Happy Merchants
National Bank are as shown in the following tables:
Happy Merchants National Bank
Income and Expense Statement (Report of Income)
Interest and fees on loans $44
Interest and dividends on securities 6
Total interest income 50

Interest paid on deposits 32

Interest on nondeposit borrowings 6
Total interest expense 38

Net interest income 12

Provision for loan losses 1
Noninterest income and fees 16
Noninterest expenses:
Salaries and employee benefits 10*
Overhead expenses 5
Other noninterest expenses 2
Total noninterest expenses 17
Net noninterest income -1

Pretax operating income 10

Securities gains (or losses) 2
Pretax net operating income 12
Taxes 2
Net operating income 10
Net extraordinary income -1
Net income 9
*Note: the bank currently has 40 FTE employees.

Happy Merchants National Bank

Report of Condition
Assets Liabilities

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Chapter 4 - Measuring and Evaluating the Performance of Banks

Cash and deposits due from banks $100 Demand deposits $190
Investment securities 150 Savings deposits 180
Federal funds sold 10 Time deposits 470
Net loans 670 Federal funds purchased 60
(Allowance for loan losses = 25) Total liabilities 900
(Unearned income on loans = 5) Equity capital
Plant and equipment 50 Common stock 20
Surplus 25
Total assets 980 Retained earnings 35
Total Capital 80
Total Earnings Assets 830 Interest-bearing deposits 650

Using these statements, calculate the following performance measures:

ROE Asset utilization

ROA Equity multiplier
Net interest margin Earnings spread
Funds management efficiency Net profit margin
Net noninterest margin Asset management efficiency

12. The following information is for Blue Sky National Bank:

Interest income $2,200

Interest expense $1,400
Total assets $45,000
Securities losses or gains $21
Earning assets $40,000
Total liabilities $38,000
Taxes paid $16
Shares of Common Stock
outstanding 5,000
Noninterest income $800
Noninterest expense $900
Provision for loan losses $100

Please calculate: ROE, ROA, NIM, Earnings per share, Net noninterest margin

13. Washington Group holds total assets of $12 billion and equity capital of $1.2 billion and has
just posted an ROA of 1.10 percent. What is the financial firm’s ROE?

Suppose Washington Group finds its ROA climbing by 50 percent, with assets and equity capital
unchanged. What will happen to its ROE? Why?
On the other hand, suppose the bank’s ROA drops by 50 percent. If total assets and equity capital
hold their present positions, what change will occur in ROE?
If ROA at Washington Group remains fixed at 0.0076 but both total assets and equity double,
how does ROE change? Why?

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Chapter 4 - Measuring and Evaluating the Performance of Banks

How would a decline in total assets and equity by half (with ROA still at 0.0076) affect the
bank’s ROE?

14. Oregon Bank reports total operating revenues of $150 million, with total operating expenses
of $130 million, and owes taxes of $5 million. It has total assets of $1.00 billion and total
liabilities of $900 million. What is the bank’s ROE?

15. Suppose a stockholder-owned thrift institution is projected to achieve a 1.10 percent ROA
during the coming year. What must its ratio of total assets to equity capital be if it is to achieve
its target ROE of 12 percent? If ROA unexpectedly falls to 0.80 percent, what assets-to-capital
ratio must it then have to reach a 12 percent ROE?

16. Watson County National Bank presents us with these figures for the year just concluded.
Please determine the net profit margin, equity multiplier, asset utilization ratio, and ROE.

Net income = $25

Total operating revenues = $135
Total assets = $1,700
Total equity capital accounts = $160

17. Crochett National Bank has experienced the following trends over the past five years (all
figures in millions of dollars). Determine the figures for ROE, profit margin, asset utilization,
and equity multiplier for this bank.

Year Net Income Total Total Total

Operating Assets Liabilities
Revenues
1 $2.7 $26.5 $300 $273
2 3.5 30.1 315 288
3 4.1 39.8 331 301
4 4.8 47.5 347 314
5 5.7 55.9 365 329

18. Using this information for Dragon International Bank and Trust Company (all figures in
millions), calculate the bank's net interest margin, noninterest margin, and ROA.

Interest income = $70 Noninterest expense =8

Interest expense = 56 Noninterest income =5
Provision for loan losses =3 Extraordinary net gains =1
Security gains (or losses) =2 Total Assets = 1000