bank performance i brent vanderheide. discussion starter q: which bank would you rather own and why?...
TRANSCRIPT
Bank Performance IBrent Vanderheide
Discussion StarterQ: Which bank would you rather own and why?
Bank A Bank BDifference
A-BInterest Income 3.55% 3.90% (0.35%)
Interest Expense 1.15% 0.60% 0.55%
Net Interest Income 2.40% 3.30% (0.90%)
Provision 0.80% 1.25% (0.45%)
Non Interest Income 1.70% 2.25% (0.55%)
Non Interest Expense 2.00% 3.00% (1.00%)
Net Overhead 0.30% 0.75% (0.45%)
Pretax Income 1.30% 1.30% -
Income Taxes 0.30% 0.30% -
Net Income 1.00% 1.00% -
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Our Journey: Year 1 Retail Strategy
Retail Strategy• Customer acquisition• Branding & marketing• Product & pricing• Delivery optimization
Bank Management Strategy• Economic value & risk• Capital considerations• Analyst influences• 360° executive
management
Financial Strategy• Financial analysis• Key performance
drivers• Earnings power• Risk considerations
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Objectives for Today’s Discussion
Understand the drivers behind Retail Bank Performance; connect drivers and outcomes
Explore Quality vs. Quantity of earnings—does it matter?
Provide some insight you can use in running your MarketSim bank and your Retail franchise back home
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By way of review…Financial statements are a tool to summarize the results of the bank’s business activities. They represent the cumulative impact of transactions done by the bank and by the bank’s customers
Balance Sheet Income Statement Represents the financial
position of the bank as of a specific point in time (the balance sheet date)
Reflects all the assets, liabilities (obligations), and shareholders equity (investment) as of that point in time
Summarizes the income and expense impact of transactions over a specific period of time
Reflects all the income or revenue generated, and all expenses or costs incurred
The bottom line result – net income (or loss!) – is added to the Retained Earnings account (part of shareholders equity) on the balance sheet
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For Example:Balance Sheet
December 31, 2013Cash $100
Loans $1,000
Total Assets $1,100
Deposits $950
Shareholders Equity $150
Total Liabilities and Shareholders Equity $1,100
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Income Statement reflects Revenue & Costs:
Income Statement for year ended December 31, 2014
Transactions from January 1, 2014 through December 31, 2014
Interest income $50 (a) Rec’d interest at 5% rate on loans
Interest expense $(19) (b) Accrued interest at 2% rate on deposits
Net Interest income $31
Non Interest income $5 (c) Service charge fee
Non-interest expense $20 (d) Paid rent and salaries for the year
Pretax income $16
Income taxes $4
Net income $12
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Balance Sheet reflects increase in Cash, Deposits, and Profits:
Balance Sheet December 31, 2013
Results of 2014 Transactions
Balance Sheet December 31, 2014
Cash $100 +50+5-20-4 $131
Loans $1,000 $1,000
Total Assets $1,100 $1,131
Deposits $950 +19 $969
Shareholders Equity
$150 +12 $162
Total Liabilities and Shareholders Equity
$1,100 $1,131
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What this looks like in MarketSim
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What this looks like in MarketSim
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How to evaluate Performance11
Q: Bank A earned a 1% ROA for the period ending 12/31/14. How do you feel about that?
Comparison Time Period Questions to Ask1. Against Itself Analysis of bank
performance against itself over time (trend)
Are the results of management’s chosen strategy becoming more evident over time?
Do I like the direction?
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Comparison Time Period Questions to Ask1. Against Itself Analysis of bank
performance against itself over time (trend)
Are the results of management’s chosen strategy becoming more evident over time?
Do I like the direction?
2. Relative to peer performance
Analysis of bank performance against peers either as of a point in time, or trended over time
Are management’s chosen strategies being executed successfully?
Are these strategies driving better outcomes than peers?
Consider changes in underlying drivers like market share, asset mix, and risk tolerance.
Quantity vs. Quality
Q: Would you rather have high earnings, or high-quality earnings?
A: Both, of course!
The value of the bank is related to the sustainability and volatility of profits, perhaps more than the recent quantity of earnings.
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Quantity of Earnings
2 classic measures to gauge the quantity of earnings:
• Return on Assets
(ROA)
• Return on Equity (ROE)
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Return on Assets (ROA)
Measures the ability of the bank's investments to generate net income
Calculated as:
Commonly expressed as a percent, with 2 decimal places
In our example, ROA is:
$12[($1100+$1131)/2]
Net IncomeAverage Total Assets
= 1.08% or 108 basis points
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Net IncomeAverage Total Assets
Return on Assets (ROA)Balance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-4 $131
Loans $1,000 $1,000
Total Assets $1,100 $1,131
Deposits $950 +19 $969
Shareholders Equity
$150 +12 $162
Total Liabilities and Shareholders Equity
$1,100 $1,131
ROA = $12[($1100+$1131)/2]
1.08% or 108 basis points
= =
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Return on Equity (ROE)
Measures the net income generated based on the shareholders interest
Calculated as:
Commonly expressed as a percent, with 1 decimal place
In our example, ROE is:
Net IncomeAverage Common Stockholders Equity
$12[($150 + $162)/2]
= 7.7%
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Net Income
Return on Equity (ROE)Balance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-4 $131
Loans $1,000 $1,000
Total Assets $1,100 $1,131
Deposits $950 +19 $969
Shareholders Equity
$150 +12 $162
Total Liabilities and Shareholders Equity
$1,100 $1,131
ROE= $12[($150+$162)/2] 7.7%= =
Avg. Common Equity
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Where is Equity in MarketSim?
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What is Equity?19Equity is a Source of Funds and serves as a ‘cushion’ on the balance sheet to reduce the risk that the bank’s creditors won’t be paid.
Investments
Loans
Non-earning
Assets
Bank A
Equity
Other Borrowings
Non-Int Bearing
Interest Bearing Deposits
Bank A
Liabilities & Shareholders Equity
Uses of Funds
Sources of Funds
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-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
1930 1940 1950 1960 1970 1980 1990 2000 2010
Commercial Bank Industry Average ROA1934 - 2013
Quantity of Earnings
Source: FDIC, http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10&Header=1
Q: What kind of ROA should a bank earn?
Commercial Bank Industry Averages (2013 most recent year)
Last 5 years 0.69%
Last 10 years 0.82%
Last 20 years 1.00%
1934 – 2013 series 0.74%
(2003, 1.35%)
(1934, -0.77%)
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The Balanced Scorecard
Q: Quantity of earnings is represented by only 2 metrics on the balanced scorecard, why?
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By way of review…
The Balanced Scorecard is intended to overcome issues with GAAP and focus on what management can control to drive sustainable earnings.
Pros (+) Cons (-)Focuses on Retail Strategy
Looks at all Drivers of Success
Contains both Leading and Lagging Indicators
Factors in Employees
May not directly sync with Exec’s incentive plans
Hard sell to CFO
Will the “Street” give you time for the Scorecard to drive
Earnings?
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Quality of Earnings
Q: Why is quality of earnings important?
A: The value of the bank is related to the sustainability and volatility of profits.
The notion of quality of earnings underlies 2 critical demands on management:
Grow the value of the Franchise
Generate Current Period Profit &1. 2.
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Quality of Earnings
• Net Interest Margin
• Asset Quality
• Non Interest Income
• Efficiency Ratio• Liquidity – Loan to
Deposit Ratio
BSI Metrics used to gauge the quality of earnings:
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Quality of Earnings - Example
Management desires to earn an ROA of 100bp, and have constructed this income statement profile to determine what rate to charge on loans:
Let’s compare that profile to recent results for the industry…
ROA 100 bp
Income Taxes + 30 bp
Non Interest Expenses + 200 bp
Non Interest Income -170 bp
Provision Expense + 80 bp
Interest Expense + 115 bp
Interest Income = 355 bp needed rate on loans
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Quality of Earnings - ExampleExample Bank Industry Average
Last 5 YearsDifference
(Example – Industry)Interest Income 3.55% 3.90% (0.35%)
Interest Expense 1.15% 0.90% 0.25%
Net Interest Income 2.40% 3.00% 0.60%
Provision Expense 0.80% 1.10% (0.30%)
Non Interest Income 1.70% 1.75% (0.05%)
Non Interest Expense 2.00% 2.95% (0.95%)
Net Overhead 0.30% 1.20% (0.90%)
Pretax Profit 1.30% 0.70% 0.60%
Income Taxes 0.30% 0.20% 0.10%
Net Income 1.00% 0.50% 0.50%
What questions would you have for management?Industry Average Source: FDIC, http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10&Header=1 (Rounded for Discussion)
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Net Interest Income
Interest income = f(rates earned on loans and investments) + f(proportion of the balance sheet made up of loans vs. securities vs. non-earning assets)
Interest expense = f(rates paid on deposits and borrowings) + f(proportion of the balance sheet funded by interest bearing liabilities vs. non-interest bearing deposits vs. equity)
Net Interes
t Incom
e
Interest
Income
Interest
Expense
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Net Interest IncomeWhich bank would have higher interest income?
Non-earning
Investments
Loans
Investments
Loans
Non-earning
Assets
Bank A Bank B
Equity
Other Borrowings
Non-Interest Bearing Dep
Interest Bearing Deposits
Equity
Other Borrowings
Non-Int Bear
Interest Bearing Deposits
Bank A Bank B
Liabilities & Shareholders Equity
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Interest expense?
Measures the difference between income generated from interest earning assets and interest paid to secure funding
Calculated as:
Commonly expressed as a percent, with 2 decimal places In our example, the NIM is:
Interest Income – Interest ExpenseAverage Earning Assets
Net Interest Margin (NIM)
$50-$19[($1000 + $1000)/2]
= 3.10%
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Net Interest Income
Income Statement for year ended December 31, 2013
Transactions from January 1, 2013 through December 31, 2013
Interest income $50 (a) Rec’d interest at 5% rate on loans
Interest expense $(19) (b) Accrued interest at 2% rate on deposits
Net Interest income $31
Non Interest income $5 (c) Service charge fee
Non-interest expense $20 (d) Paid rent and salaries for the year
Pretax income $16
Income taxes $4
Net income $12
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Net Interest Income
Net Interest Margin (NIM)Balance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-4 $131
Loans $1,000 $1,000
Total Assets $1,100 $1,131
Deposits $950 +19 $969
Shareholders Equity
$150 +12 $162
Total Liabilities and Shareholders Equity
$1,100 $1,131
NIM= $50 - $19[($1000+$1000)/2] 3.10%= =
Avg. Earning Assets
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HB&T Year 7 TCB Veritas Resource
Net Interest Margin (Assets) $173,980,206 $199,379,281 $146,744,328 $245,814,322 $265,658,098Interest Bearing Assets $5,539,461,953 $5,515,507,930 $6,065,791,996 $7,058,627,212 $6,255,544,808Net Interest Margin / Interest Bearing Assets 3.14% 3.61% 2.42% 3.48% 4.25%
Net Interest Income (Liabilities) $132,221,554 $125,745,629 $174,373,117 $97,491,695 $120,827,783Interest Bearing Liabilities $5,739,459,725 $5,423,700,775 $7,182,312,000 $6,232,652,325 $6,262,738,350Net Interest Margin / Interest Bearing Liabilities 2.30% 2.32% 2.43% 1.56% 1.93%
% of Average AssetsTotal Net Interest Income 5.53% 5.89% 5.29% 4.86% 6.18%Loan Loss Provisions - 1.63% - 1.96% - 1.58% - 2.43% - 2.90%Treasury Balancing Cost - 0.02% - 0.01% - 0.09% - 0.06% 0.00%Net Interest Margin after LLP and Treasury 3.88% 3.93% 3.63% 2.37% 3.28%Non Interest Revenue 2.60% 3.13% 2.00% 1.47% 1.80%Total Revenue 6.48% 7.06% 5.62% 3.84% 5.08%
Variable Costs - 3.18% - 3.75% - 2.46% - 1.90% - 2.48%Fixed Costs - 0.61% - 0.54% - 0.54% - 0.56% - 0.36%Delivery Costs - 0.82% - 1.19% - 1.50% - 0.58% - 0.72%Marketing Costs - 0.12% - 0.13% - 0.05% - 0.12% - 0.12%Service Costs - 0.25% - 0.20% - 0.23% - 0.20% - 0.22%Corporate, Compliance, and Regulatory Costs - 0.29% - 0.29% - 0.27% - 0.23% - 0.26%Total Costs - 5.28% - 6.10% - 5.05% - 3.58% - 4.16%Net Income before taxes 1.20% 0.97% 0.57% 0.26% 0.91%
Strategy in the Sim…Q: Which portfolio would you rather have based on Margin?
Net Interest Margin / Interest Bearing Assets 2.39% 2.28% 2.87% 1.38% 1.93%
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Provision
Provision = the credit loss expense for the (year; quarter; month)
Provision expense is based on a forecast of future credit losses. This forecast reflects: Recent past results, for example loan charge-offs in the last
year Forward looking indicators, for example the percentage of
loans that are delinquent as of the balance sheet date Environmental factors, for example the health of the housing
market may influence losses in a mortgage portfolio
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What is Risk?
Q: Is RISK the occurrence of a LOSS?A: NO!
Losses are an expected part of doing business Expected losses are included in the calculation
when you set the price. For example:
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Setting a Loan Rate
Income Contribution RateDesired Profit 1.50%Income Tax .50%Operating Expenses 1.50%Expected Credit Loss 1.00%Cost of Funds 0.75%Needed Customer Rate 5.25%
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What is Risk?
Risk is volatility in the range of possible outcomes; it is the possibility
of not achieving your objective.
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What is Risk?
Q: Is RISK the occurrence of a LOSS?A: No!
Risk taking results in volatility of [credit losses, net interest income, liquidity, etc.] – reflecting business choices
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Provision
Income Statement for year ended December 31, 2014
Transactions from January 1, 2014 through December 31, 2014
Interest income $50 (a) Rec’d interest at 5% rate on loans
Interest expense $(19) (b) Accrued interest at 2% rate on deposits
Net Interest income $31
Provision for Credit Loss $10 (e) 1% expected loss on $1,000 of loans
Non Interest income $5 (c) Service charge fee
Non-interest expense $20 (d) Paid rent and salaries for the year
Pretax income $6
Income taxes $1
Net income $5
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Allowance for LossesBalance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-1 $134Loans $1,000 $1,000
ALLL $0 +10 ($10)Total Assets $1,100 $1,124
Deposits $950 +19 $969Shareholders Equity
$150 +5 $155
Total Liabilities and Shareholders Equity
$1,100 $1,124
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Asset Quality on BSI
Provision = f(expected loss by asset class as an outcome of risk appetite, credit standards, and go-to-market strategy) + f(environmental factors)
Average Earning Assets = f(target customer segments, product design, credit policy, other competitive factors)
Provision to Assets
Provision
Average
Earning
Assets
40
Measures the level of current period provision (expected loss) as a percent of average earning assets
Calculated as:
Expressed as a percent, with 2 decimal places In our example, Provision to Assets is:
ProvisionAverage Earning Assets
Asset Quality on the BSI
$10[($1000 + $990)/2] = 1.01%
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Asset Quality on the BSIBalance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-1 $134
Loans $1,000 $1,000ALLL $0 +10 ($10)Total Assets $1,100 $1,124
Deposits $950 +19 $969Shareholders Equity
$150 +5 $155
Total Liabilities and Shareholders Equity
$1,100 $1,124
Provision= $10
[($1000+$990)/2] 1.01%= = Avg. Earning Assets
Provision to Assets
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Asset Quality43
Which bank would have better Asset Quality, all else held equal?
Non-earning
Investments
Home Equity
Investments
Home Equity
Non-earning
Assets
Bank A Bank B
Credit CardCredit Card
Lines / LoansLines / Loans
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HB&T Year 7 TCB Veritas Resource
Net Interest Margin (Assets) $173,980,206 $199,379,281 $146,744,328 $245,814,322 $265,658,098Interest Bearing Assets $5,539,461,953 $5,515,507,930 $6,065,791,996 $7,058,627,212 $6,255,544,808Net Interest Margin / Interest Bearing Assets 3.14% 3.61% 2.42% 3.48% 4.25%
Net Interest Income (Liabilities) $132,221,554 $125,745,629 $174,373,117 $97,491,695 $120,827,783Interest Bearing Liabilities $5,739,459,725 $5,423,700,775 $7,182,312,000 $6,232,652,325 $6,262,738,350Net Interest Margin / Interest Bearing Liabilities 2.30% 2.32% 2.43% 1.56% 1.93%
% of Average AssetsTotal Net Interest Income 5.53% 5.89% 5.29% 4.86% 6.18%Loan Loss Provisions - 1.63% - 1.96% - 1.58% - 2.43% - 2.90%Treasury Balancing Cost - 0.02% - 0.01% - 0.09% - 0.06% 0.00%Net Interest Margin after LLP and Treasury 3.88% 3.93% 3.63% 2.37% 3.28%Non Interest Revenue 2.60% 3.13% 2.00% 1.47% 1.80%Total Revenue 6.48% 7.06% 5.62% 3.84% 5.08%
Variable Costs - 3.18% - 3.75% - 2.46% - 1.90% - 2.48%Fixed Costs - 0.61% - 0.54% - 0.54% - 0.56% - 0.36%Delivery Costs - 0.82% - 1.19% - 1.50% - 0.58% - 0.72%Marketing Costs - 0.12% - 0.13% - 0.05% - 0.12% - 0.12%Service Costs - 0.25% - 0.20% - 0.23% - 0.20% - 0.22%Corporate, Compliance, and Regulatory Costs - 0.29% - 0.29% - 0.27% - 0.23% - 0.26%Total Costs - 5.28% - 6.10% - 5.05% - 3.58% - 4.16%Net Income before taxes 1.20% 0.97% 0.57% 0.26% 0.91%
Net Interest Margin on Assets - LLP 1.51% 1.66% 0.84% 1.05% 1.35%
Strategy in the Sim…Q: Which loan portfolio would you rather have?
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Net Overhead
Non Interest Income is primarily influenced by the business mix of the bank. Major categories of non interest income include deposit service charges, debit and credit card interchange and fees, trust fees, and mortgage fees
Non Interest Expense compromises both recurring expenses (major categories include personnel expenses, facilities (including branch) costs, operations and technology) and non-recurring expenses (notably goodwill impairment)
Consider the sustainability question – are all fees created equal? Should all expenses be viewed in the same light?
Net Overh
ead
Non Interes
t Incom
e
Non Interes
t Expen
se
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Measures Non Interest Income contribution to ROA (as a percent of average earning assets)
Calculated as:
Expressed as a percent, with 2 decimal places In our example, Non Interest Income to Assets is:
Non Interest IncomeAverage Earning Assets
Non Interest Income to Assets
$5[($1000 + $990)/2] = 0.50%
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Non Interest Income to AssetsBalance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-1 $134
Loans $1,000 $1,000ALLL $0 +10 ($10)Total Assets $1,100 $1,124
Deposits $950 +19 $969Shareholders Equity
$150 +5 $155
Total Liabilities and Shareholders Equity
$1,100 $1,124
Non Interest Income= $5
[($1000+$990)/2] 0.50%= = Avg. Earning Assets
Non Int. Inc. to Assets 47
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Measures the level of operational expense it takes to generate a dollar of revenue
Calculated as:
Commonly expressed as a percent, with 1 decimal places In our example, the Efficiency Ratio is:
Non Interest ExpenseNet Interest Income + Non Interest Income
Efficiency Ratio
$20($5 + $31)
= 55.5%
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Efficiency RatioIncome Statement for year ended December 31, 2014
Transactions from January 1, 2014 through December 31, 2014
Interest income $50 (a) Rec’d interest at 5% rate on loansInterest expense $(19) (b) Accrued interest at 2% rate on depositsNet Interest income $31Provision for Credit Loss $10 (e) 1% expected loss on $1,000 of loansNon Interest income $5 (c) Service charge feeNon-interest expense $20 (d) Paid rent and salaries for the year
Pretax income $6Income taxes $1Net income $5
Non-interest Expense= $20
($5+$31)= =55.5% Total RevenueEfficiency
Ratio
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Q: What causes bank failures?A: Insolvency (meaning not enough capital)?
Or lack of liquidity?
Consider IndyMac
Liquidity Risk
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Liquidity risk is the possibility that over a specific time horizon the bank will become unable to settle obligations
with immediacy
Liquidity Risk
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Liquidity Risk
How you can create liquidity risk As chief retail officer, you create two products – 5 year
fixed rate loans, and money market savings accounts Loan customers have the option to prepay, but the
bank has no option to demand early payment Deposit customers have the option to withdraw any
and all funds daily, but the bank has no option to restrict withdrawals
Does the bank have liquidity risk?
52
Measures the proportion of deposit funds that are invested in less liquid loan assets
Calculated as:
Commonly expressed as a percent, with 1 decimal places In our example, the Loan to Deposit Ratio as of
December 31, 2013 is:
Total LoansTotal deposits
Loan to Deposit Ratio
$990$969
= 102.2%
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Loan to Deposit RatioBalance Sheet
December 31, 2013Results of 2014
TransactionsBalance Sheet
December 31, 2014Cash $100 +50+5-20-1 $134
Loans $1,000 $1,000ALLL $0 +10 ($10)Total Assets $1,100 $1,124
Deposits $950 +19 $969Shareholders Equity
$150 +5 $155
Total Liabilities and Shareholders Equity
$1,100 $1,124
Total Loans= $990
$969 102.2%= = Total Deposits
Loan to Deposit Ratio
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HB&T Year 7 TCB Veritas Resource
AssetsLoans $608,561,427 $358,887,069 $213,219,396 $458,271,892 $944,233,720Lines $475,559,775 $72,080,970 $1,004,664,180 $907,454,640 $874,156,020Credit Card $1,535,792,751 $1,703,403,891 $1,174,660,420 $1,799,860,680 $2,257,047,068Home Equity $2,919,548,000 $3,381,136,000 $3,673,248,000 $3,893,040,000 $2,180,108,000
Total $5,539,461,953 $5,515,507,930 $6,065,791,996 $7,058,627,212 $6,255,544,808
LiabilitiesChecking Total $2,282,910,600 $2,721,426,500 $3,378,438,950 $1,457,345,550 $2,801,247,000Savings $370,967,925 $180,935,625 $389,187,650 $491,917,950 $494,713,800Investment $28,584,950 $29,772,800 $66,568,400 $29,895,000 $8,212,050Money Market $1,466,264,250 $289,951,350 $1,110,645,000 $2,124,188,325 $1,280,256,000CD $1,590,732,000 $2,201,614,500 $2,237,472,000 $2,129,305,500 $1,678,309,500
Total $5,739,459,725 $5,423,700,775 $7,182,312,000 $6,232,652,325 $6,262,738,350
TreasuryTreasury Borrowing $0 $91,807,155 $0 $825,974,887 $0Treasury Lending $199,997,772 $0 $1,116,520,004 $0 $7,193,543Treasury Cost* $999,989 $459,036 $5,582,600 $4,129,874 $35,968
Liquidity RiskLoans $5,539,461,953 $5,515,507,930 $6,065,791,996 $7,058,627,212 $6,255,544,808Deposits $5,739,459,725 $5,423,700,775 $7,182,312,000 $6,232,652,325 $6,262,738,350Loan- to- deposit Ratio 96.5% 101.7% 84.5% 113.3% 99.9%
* Treasury Rate: 0.50%
Strategy in the Sim…Q: Which Market$im bank illustrates the lowest liquidity risk?
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The Balanced Scorecard
We have reviewed Quantity of Earnings and a handful of normative metrics on Quality of Earnings, but what about the Drivers of Earnings?
c
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Retail Bank Profitability Equation
NIM Net Interest Margin NII Non Interest Income NIE Non Interest Expense RLL Retail Loan Losses
NIM NII NIE RLL NIB
T
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Customer Based Profitability
Moves financials out of accounting to the people who generate the profits
Can be computed on a single customer, a geography, or a market segment
Actionable information
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Customers
Products per
Customer
Product Profitab
ilityDelivery
Costs Profits
Drivers and Outcomes
In order to drive long-term sustainability and current period balance sheet and income statement outcomes, Retail officers must focus on the underlying drivers.
Drivers must… Outcomes must… Be actionable Be measurable Be controllable by Retail
bank management Lead to long-term
predictable expected outcomes
Represent the future of your strategy
Be long-run focused Be not only bottom line
focused Drive current period
financial performance and great long-term value
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Drivers on the BSI
Driver Description Customer ProfitabilityCRA LMI Performance Specialized products and
marketing Increased delivery costs
Product Breadth Products offered Broader customer appeal Increased product cost
Access to Delivery Branches, ATMs and Channels
Increased delivery costs Customer appeal & retention
Customer Service Call Center, Mobile & Online Increased delivery costs Customer appeal & retention
Market Share Customers, Balances More customers! Increased efficiency
Turnover Customers gained / lost Customer retention / growthCost per Tran Expenses, transactions Optimize delivery cost
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Bank Performance Summary
Quantity
Quality
Business Strategy
Drivers
Outcomes
BSI Metric
ROE, ROA
Asset Quality, Liquidity Ratio, Efficiency Ratio, NIM, Non-interest income to Assets
CRA, Product Breadth, Access to Delivery, Customer Service, Market Share, Turnover, Cost per Tran
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Why does this Matter?
This matters because we are managing a bank to create value!
Stock Price = EPS x P/E[earnings per share; price earnings ratio]
P/E = f(future earnings, variability of future earnings)
Variability = f(inherent risks, quality of risk management)
62
Compare two banks … different strategies, different results
Bank A Bank BDifference
A-BInterest Income 3.55% 3.90% (0.35%)
Interest Expense 1.15% 0.60% 0.55%
Net Interest Income 2.40% 3.30% (0.90%)
Provision 0.80% 1.25% (0.45%)
Non Interest Income 1.70% 2.25% (0.55%)
Non Interest Expense 2.00% 3.00% (1.00%)
Net Overhead 0.30% 0.75% (0.45%)
Pretax Income 1.30% 1.30% -
Income Taxes 0.30% 0.30% -
Net Income 1.00% 1.00% -
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Compare two banks … different strategies, different results
Bank A Strategy Low investment operator (but might look like low cost operator) National geographic reach Reliance on wholesale deposits for funding Reliance on broker network for loan origination Limited customer cross sell and depth of relationship Non interest income primarily related to fees from selling loans
Bank B Strategy Tight geographic focus, dense retail delivery network Reliance on customer deposit base for funding Focus on in-market and customer cross-sell for loan origination High depth of relationship (number of services per household) Non interest income primarily related to core deposit productsLet’s look at the results again!
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Compare two banks … different strategies, different results
Bank A Bank BDifference
A-BInterest Income 3.55% 3.90% (0.35%)
Interest Expense 1.15% 0.60% 0.55%
Net Interest Income 2.40% 3.30% (0.90%)
Provision 0.80% 1.25% (0.45%)
Non Interest Income 1.70% 2.25% (0.55%)
Non Interest Expense 2.00% 3.00% (1.00%)
Net Overhead 0.30% 0.75% (0.45%)
Pretax Income 1.30% 1.30% -
Income Taxes 0.30% 0.30% -
Net Income 1.00% 1.00% -
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Back to our Objectives…
Understand the drivers behind Retail Bank Performance; connect drivers and outcomes
Explore Quality vs. Quantity of earnings—does it matter?
Provide some insight you can use in running your MarketSim bank and your Retail franchise back home
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