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What Drives a Banks
Value starts with earnings, so let’s break down exactly how bank’s put
dinner on the table.
In this case study, we will use Citigroup (NYSE: C), Wells Fargo (NYSE:
WFC), and Bank of America (NYSE: BAC) to demonstrate exactly what
First, let’s begin with Return on Equity (ROE), the ratio of
a bank’s earnings to its capital.
Equity Multiplier (Leverage)
Return On Assets (ROA)
Comparing ROE for Bank of America, Wells Fargo, and Citi:
Q2 2013 ROE ROA Capital Ratio
$BAC 6.55% 0.74% 11.30%
$WFC 14.02% 1.55% 11.06%
$C 8.8% 0.89% 10.11%
All financial data sourced from Yahoo! Finance and company earnings presentations.
Wells’ outperformance in ROE is clearly driven by higher
ROA. So let’s now drill down into ROA.
ROA Asset UtilizationProfit Margin
Where asset utilization measures how productive the bank’s
assets are (i.e., Does $10 of assets yield $0.50 or $1?).
Comparing ROA for Bank of America, Wells Fargo, and Citi:
Q2 2013 ROA Profit Margin Asset Utilization
$BAC 0.74% 13.73% 5.39%
$WFC 1.55% 24.58% 6.29%
$C 0.89% 16.97% 5.20%
Profit margin defined here as total income (total interest income plus non interest income). Asset
utilization calculated as annualized total income divided by average total assets.
Once again, the driving factor behind Wells’
outperformance is quite clear – much better profit
margins and slightly better asset utilization.
The asset utilization ratios look similar in terms of the
percentages; however, the 1% advantage for Wells across
its $1.4 trillion in average total assets translates to a
substantial advantage in raw dollars.
Let’s drill down one final time into profit margin. For
banks, expenses break down into two overarching
categories: interest expense and non-interest expense.
To measure interest expense on a relative basis, we will
use the net interest margin. This is a measure of the
difference the banks bring in from interest income on
loans and interest paid out to depositors.
To gauge non-interest expense on a relative basis, we will
use the efficiency ratio. This is defined as the ratio of non-
interest expenses to revenue.
For this ratio, a lower ratio indicates fewer expenses per
dollar of revenue. So, lower = better.
Q2 2013 Net Interest Margin Efficiency Ratio
$BAC 2.44% 76.62%
$WFC 3.46% 57.3%
$C 2.85% 59%
Once again, it’s clear to see Wells’ advantage. However, it
is only now coming into focus why Citi outperformed
Bank of America…
The efficiency ratio indicates that Citi is doing a better
job managing non-interest expenses, which is driving
its 200+ basis point ROE advantage over B of A.
Taking this systematic approach to analyzing banks is a
simple and fundamentally sound method to uncovering the
driving factors in company performance.
In this case, it highlighted just how strongly Wells Fargo has
performed recently, and also points to the work that still
needs to be done at Bank of America.