2 Important Metrics You Should Look At With Bank Stocks

The topic of rate hikes by the Federal Reserve in the U.S. has captured plenty of attention lately from the finance community around the world. Last December, the Fed had raised its benchmark interest rates by 0.25 percentage points to a range of 0.25%-0.50%. It was the first time the Fed had increased interest rates in nearly a decade.

A few days ago, the Fed held one of its regular meetings and announced that it would be keeping its benchmark interest rate in the U.S. steady for now at the level of 0.25%-0.50%. The Fed also mentioned that it expects to push through only two rate hikes this year as opposed to the previously expected number of four.

Interest rates play a very important role for banks, which is why they may be of interest to current or prospective investors in bank stocks.

Essentially, banks earn revenue based on the difference between the interest rates they charge borrowers and the interest they pay to their lenders (which include depositors). This difference in the two interest rates is called the net interest margin, or commonly seen in bank reports as the NIM. That’s the first key metric to look at with bank stocks.

As you may have have guessed by now, a higher NIM would mean that a bank charges more interest than it pays. This leads to the bank keeping more of the interest-difference as revenue and thus also as profit.

The other important metric to consider when analyzing a bank is its loan-to-deposit ratio. It’s commonly abbreviated as LDR in a bank’s reports.

The LDR shows the percentage of a bank’s deposits that the bank is lending out. It’s an indication of how a bank’s core funds are being used for lending. A higher ratio is a sign that more of a bank’s deposits are being lent out. The LDR is also a gauge of a bank’s liquidity risks. For instance, if a bank has lent out a lot of its deposits, it’d be harder for the bank to meet emergency withdrawal requests from depositors.

Let’s take a closer look at Singapore’s largest bank, DBS Group Holdings Ltd (SGX: D05), to see how the NIM and LDR plays out in real life.

DBS has seen its NIM increase from 1.62% in 2013 to 1.77% in 2015. This in turn has helped lead to an increase in net interest income (one component of a bank’s revenue) for DBS from S$5.57 billion to S$7.10 billion over the same period. This is a real-life case of how an increase in NIM can boost a bank’s revenue.

Moving on to the LDR, the metric has increased from 85% in 2013 to 88% in 2015. What this means is that the bank’s liquidity risks have increased.

From the above two metrics it looks like DBS is a mixed bag. The aforementioned lower frequency of rate hikes by the Fed in 2016 also indicates that the NIMs for banks in general are probably going to increase at a slower rate than otherwise. This thus does not favor DBS.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Esjay owns shares in DBS Group Holdings.