How Healthy Are Big U.S. Banks?

With the help of SNL Financial, BusinessWeek's scorecard ranks 10 big banks using several key financial metrics

With so many questions swirling about the health of big U.S. banks, BusinessWeek decided to take a look at just where some of the top institutions stand. Specifically, we asked bank analysis firm SNL Financial to screen the 10 largest U.S. banks in terms of market capitalization based on important financial ratios that provide important clues to how well a bank performs financially—and how solid its balance sheet is.

The banks in the following table were screened for how they performed through the second quarter of 2008 in several key categories. Here they are, with definitions provided by Standard & Poor's Equity Research and

• Return on average assets (ROAA): This is a comprehensive measure of bank profitability—a bank's net income divided by its average total assets during a given period. A trend of rising ROAA is generally positive, provided it is not the result of excessive risk-taking. Because banks are highly leveraged, they tend to have low ROAAs relative to other industries. Historically, most banks have had ROAAs within a range of 0.60% to 1.50%.

Profitability measures like ROAA "build upon a bank's existing equity in the form of retained earnings (earnings after dividends), and losses will negatively impact equity," notes Sebastian Hindman, an analyst with SNL. "So continued losses will slowly, or rapidly, depending on the size of the losses, diminish the equity of an institution."

• Return on average equity (ROAE): Another measure of profitability, usually considered in conjunction with ROAA, is return on equity. A bank's ROE is calculated by dividing net income by average shareholders' equity. Because shareholders' equity normally backs only a small fraction (usually 5% to 10%) of a bank's assets, ROE is much larger than ROAA—typically, ranging from 10% to 25%. In 2007, the industry's average ROE was 8.17%, compared with 12.34% a year earlier.

• Net interest margin (NIM): The NIM is calculated by dividing the tax-equivalent net interest income by average earning assets. (Tax-equivalent net interest income is calculated by subtracting interest expense from tax-equivalent interest income.)

A NIM of less than 3% is generally considered low, notes S&P; more than 5% is very high. This range is only a rough guideline, however, because the NIM can vary with the particular business mix of individual banks. The NIM tends to be higher at small retail banks, credit-card banks, and consumer lenders than at large wholesale banks, international banks, and mortgage lenders.

A widening NIM is a sign of successful management of assets and liabilities, while a narrowing NIM indicates a profit squeeze. According to the Federal Deposit Insurance Corp. (FDIC), the industry's average NIM was 3.29% in 2007, down slightly from 3.31% in 2006, but down more sharply from 3.49% in 2005.

• Nonperforming assets (NPA)/assets: A loan or lease that is not meeting its stated principal and interest payments is a categorized as a nonperforming asset. Banks usually classify as nonperforming assets any commercial loans which are more than 90 days overdue and any consumer loans which are more than 180 days overdue. This metric shows what percentage of a bank's total assets are nonperforming.

"[A]s nonperforming asset levels increase, banks are forced to increase reserves," notes Hindman. Any increase in reserves is taken out of income in the form of a provision for loan losses, which diminished net income, and thus affects the equity of an institution.

• Reserves/NPA: To protect banks from possible default by loan customers at some point in the future, they are required to maintain a reserve for loan losses. This metric shows just how well a bank has set aside reserves for nonperforming assets. A reserves/NPA equaling 100.0% means that for every $1 of nonperforming assets, $1 is reserved for that loss, says Hindman.

• Tier 1 capital: Risk-based standards consider differences in the risk profiles among banks to account for off-balance-sheet exposure and to encourage banks to hold liquid assets. Assets and off-balance-sheet items are assigned to broad risk categories, each representing various weightings. Capital ratios represent capital as a percentage of total risk-weighted assets. The minimum guideline for the ratio of total capital to risk-weighted assets is 8.0%. At least half of total capital must consist of Tier 1 capital: common equity and certain preferred stock, less goodwill and other intangible assets.

The Tier 1 ratio is "sort of the key metric in evaluating a bank's safety and soundness," notes Hindman. "If this ratio falls below the regulatory minimum, regulators may issue enforcement actions. If the bank isn't able to restore a sufficient capital position it will be deemed insolvent and fail."

All these metrics are "important and interrelated," says Hindman. "When looking at these institutions you want to see solid profitability, low NPAs/assets, and sufficient coverage of NPAs in the form of reserves."

Performance of the Top 10 Publicly Traded U.S. Banks and Thrifts

Company  Assets ($B)  ROAA (%)  ROAE (%) Efficiency Ratio (%) NetInterest Margin (%) NPAs/ Assets (%) Reserves/ NPAs (%) Tier 1 Ratio (%) Market Cap ($M)
Citigroup 2,100.4 -0.67 -11.96 71.12 2.69 0.67 148.26 8.74 97,799.3
JPMorgan Chase 1,775.7 0.69 8.64 63.90 2.55 0.35 212.51 9.15 141,502.9
Bank of America 1,716.9 0.50 5.77 57.07 2.72 0.59 168.28 8.25 153,858.2
Wachovia 812.4 -1.03 -10.40 70.39 2.82 1.48 89.60 8.00 30,806.9
Wells Fargo 609.1 1.29 15.23 55.02 4.70 0.77 157.18 8.24 113,464.3
Washington Mutual 309.7 -1.92 -24.70 72.97 2.99 3.77 72.46 9.96 4,655.6
U.S. Bancorp 246.5 1.75 19.04 45.72 3.53 0.46 221.85 8.47 58,933.6
Bank of New York 201.2 1.15 7.65 65.34 1.86 0.14 126.52 9.33 45,785.5
SunTrust Banks 177.2 0.72 7.04 66.34 3.13 1.77 58.33 7.47 16,733.0
National City 153.7 -1.51 -15.98 71.38 3.22 2.03 109.88 11.06 3,721.5

Reflects financial performance over the last 12 months ended June 30, 2008. Market capitalization data is as of Sept. 12, 2008.

NPAs = nonperforming assets and includes other real estate owned and restructured loans. Government guaranteed loans are excluded.

DATA: SNL Financial

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