Key Financial Ratios to Analyze Retail Banks

Among the key financial ratios, investors and market analysts specifically use to evaluate companies in the retail banking industry are net interest margin, the loan-to-assets ratio, and the return-on-assets (ROA) ratio. The analysis of banks and banking stocks has always been particularly challenging because of the fact banks operate and generate profit in such a fundamentally different way than most other businesses. While other industries create or manufacture products for sale, the primary product a bank sells is money.

The financial statements of banks are typically much more complicated than those of companies engaged in virtually any other type of business. While investors considering bank stocks look at such traditional equity evaluation measures as price-to-book (P/B) ratio or price-to-earnings (P/E) ratio, they also examine industry-specific metrics to more accurately evaluate the investment potential of individual banks.

The retail banking industry includes those banks that provide direct services such as checking accounts, savings accounts, and investment accounts, along with loan services, to individual consumers. However, most retail banks are, in fact, commercial banks that service corporate customers as well as individuals. Retail banks and commercial banks typically operate separately from investment banks, although the repeal of the Glass-Steagall Act legally allows banks to offer both commercial banking services and investment banking services. The retail banking industry, like the banking industry overall, derives revenue from its loans and services.

In the United States, the retail banking industry is divided into the major money center banks, with the big four being Wells Fargo, JPMorgan Chase, Citigroup and Bank of America, and then there are regional banks and thrifts. In analyzing retail banks, investors consider profitability measures that provide performance evaluations considered most applicable to the banking industry.

Net interest margin is an especially important indicator in evaluating banks because it reveals a bank’s net profit on interest-earning assets, such as loans or investment securities. Since the interest earned on such assets is a primary source of revenue for a bank, this metric is a good indicator of a bank's overall profitability, and higher margins generally indicate a more profitable bank. A number of factors can significantly impact net interest margin, including interest rates charged by the bank and the source of the bank's assets. Net interest margin is calculated as the sum of interest and investment returns minus related expenses; this amount is then divided by the average total of earning assets. (For more, see: What Net Interest Margin Is Typical for a Bank?)

The loan-to-assets ratio is another industry-specific metric that can help investors obtain a complete analysis of a bank's operations. Banks that have a relatively higher loan-to-assets ratio derive more of their income from loans and investments, while banks with lower levels of loans-to-assets ratios derive a relatively larger portion of their total incomes from more-diversified, noninterest-earning sources, such as asset management or trading. Banks with lower loan-to-assets ratios may fare better when interest rates are low or credit is tight. They may also fare better during economic downturns.

The return-on-assets (ROA) ratio is frequently applied to banks because cash flow analysis is more difficult to accurately construct. The ratio is considered an important profitability ratio, indicating the per-dollar profit a company earns on its assets. Since bank assets largely consist of money the bank loans, the per-dollar return is an important metric of bank management. The ROA ratio is a company's net, after-tax income divided by its total assets. An important point to note is since banks are highly leveraged, even a relatively low ROA of 1 to 2% may represent substantial revenues and profit for a bank. (For more, see: What is the Formula for Calculating Return on Assets (ROA)?