FIN 4303 Commercial Bank Project Assignment
Order ID:89JHGSJE83839 Style:APA/MLA/Harvard/Chicago Pages:5-10 Instructions:
FIN 4303 Commercial Bank Project Assignment
FIN 4303 – Commercial Banking Assignment – Part 1
Return on equity equals the product of the equity multiplier and return on assets. It measures the
net income produced for each dollar of equity capital. The equity multiplier reflects the amount of leverage the bank uses to finance its assets. As the equity multiplier increases, the firm’s solvency risk increases. Return on assets measures net income produced for each dollar of total assets. Return on assets is the product of asset turnover and profit margin. Profit margin represents the firm’s ability to control expenses. Asset turnover measures the ability to produce net income from assets. These ratios are most useful when used as relative valuations against other firms in the commercial banking industry or over time1.
1 Saunders, Anthony. Financial Markets and Institutions
Return on Assets .5%
Asset Turnover 3%
Equity Multiplier 12.1 times
Return on Equity 6.3%
Profit Margin 17.3%
2
Figure 1: JPMorgan Chase & Co. 15
Figure 2: Industry 15
Figure 3:
Ratio Analysis 15
15 http://www.fdic.gov
3
Interpreting the Trends
From 2000 to 2001, JPMorgan Chase & Co.’s (JPM) ROE decreased resulting from a decline in net income, and thus profit margin. The recession had a large impact on JPM in 2001. Net income dropped due to unfavorable spreads, reductions in asset values, and less liquidity in equity markets2. Losses on private equity investments and lower investment banking fees caused revenues to decline3. The investment banking segment’s operating revenue shrank in reaction to reduced demand for M&A and equity underwriting in the market4. The firm also incurred higher non-interest expenses, namely merger and restructuring costs, related to the JP Morgan and Chase merger. JPM recognized higher than expected charge-offs in consumer and loan portfolios, forcing them to increase their provisions for loan losses5.
Over the next years, from 2002 to 2003, JPM was able to significantly increase its profit margin as a result of a 64% decrease in the provisions for loan losses that had been increased the previous year. This decrease reflects improvement in JPM’s previously troubled commercial loan portfolio, as well as a higher volume of credit card securitizations. The higher profit margin caused ROE to increase from 1.6% to 11.5%, and also resulted in an increased ROA. JPM’s total assets declined relative to equity, and they had to turn to outside, more costly debt financing due to reduced demand for their loans; these actions were at the root of the decreasing equity multiplier6.
From 2003 to 2004, JPM’s previously inflated ROE decreased from 11.5% to 2.9% as a result of a large increase in equity capital, primarily the result of JPM’s merger with Bank One. Also as a result of this merger, noninterest expenses increased from $19 trillion to $30 trillion. Although this 8.6% decrease in ROE is large, it merely offsets the prior increase of 9.9%, and in fact the 2.9% ROE remains higher than the 1.6% that was recorded at the beginning of 2002. JPM’s lower net income in 2004 can be attributed to merger costs, charges to conform to accounting policies as a result of the merger, and a charge to increase litigation reserves. Lower net income in this period led to a lower ROE, ROA, and profit margin. According to the annual report, had JPM not incurred these charges, ROE would have been 11% 7. Further eroding potential earning was an increase in competitive pressures which forced prices down for loan models8.
ROE significantly increased from 2004 to 2005. Due to healthy growth in the economy, net income increased and resulted in higher profit margins and ROA than the previous year. During this time, short term interest rates continued to rise and capital and equity markets remained strong9. The equity markets remained strong in 2006, and JPM’s margins and returns held steady. This would later be recognized as the calm before the storm.
In 2007, the mortgage crisis weakened the credit market10, and ultimately caused many troubled wholesale and consumer loans. JPM had not planned for this to happen and was forced to once again increase provisions for loan losses. JPM’s acquisition of Washington Mutual and Bear Stearns resulted in
2 2001 Annual Report, pg. 24 3 2002 Annual Report, pg. 69 4 2001 Annual Report, pg. 30 5 2002 Annual Report, pg. 69 6 2003 Annual Report, pg. 24 7 2004 Annual Report, pg. 20 8 “Report on the condition of the U.S. banking industry: 4th Quarter, 2004.” Federal Reserve Reports FRY-9C and FR Y-9LP. http://www.thefreelibrary.com/Report+on+the+condition+of+the+U.S.+banking+industry:+fourth+quarter,-a0134672382. 9 2005 Annual Report, pg. 25 10 2008 Annual Report, pg. 35