Advisors or seasoned clients who try to delve into the heart of the banks’ financial statements, hoping to compare them head to head, will have a virtually impossible task before them.

The reason: the banks have different mixes of business and present financial results in different ways. Even if you try adjustments in hopes of making the calculations more viable, you will never be strictly comparing apples with apples.

For example, consider the banks’ efficiency ratio — their non-interest expenses as a percentage of gross revenue. Royal Bank of Canada’s calculation puts its at 56.8% for the first six months of fiscal 2005 ended April 30, which is lower than long-time efficiency leader Bank of Nova Scotia’s 57.4%

However, Royal Bank’s calculation excludes its insurance expenses, which cover insurance policyholder benefits, claims and acquisition costs. These are substantial, totalling $622 million in the second quarter.
Instead, the expenses appear as a separate line in the income statement, after revenue but before non-interest expenses. Royal Bank says its calculation “is modelled after other large, best-practice North American financial institutions with substantial insurance operations.”

Some analysts go along with the view, feeling it’s best to stick with the way the bank’s management looks at expense ratios. Others, however, think that either the insurance expenses should be netted out of revenue or included in non-interest expenses. Excluding insurance revenue is not an option because the revenue is not broken out.

If Royal Bank’s insurance expenses were netted out of revenue, the efficiency ratio would rise to 64.3%. If they are included in non-interest expenses, the ratio is 68.7%.

Robert Long, analyst at Toronto-based Dominion Bond Rating Service, suggests using the first method, on the theory that insurance is not part of normal banking operations.

The problem is that strictly comparable efficiency ratios don’t exist because of differences in the mix of retail banking, wealth management and wholesale/corporate business.

“Each of these businesses have unique cost structures and their proportion in the revenue and profit mix of any one bank will obviously impact the overall reported efficiency result. Unfortunately, disclosure is not such that it is reasonable to disaggregate each bank into its component business units to consider a more ‘apples-to-apples’ analysis,” says Jason Bilodeau, director of UBS Securities Canada Inc., who tracks the Canadian bank and insurance sector.

There are other factors, however, for which analysts can make some adjustments to produce better comparability. One is using revenue on a tax-adjusted basis rather than gross revenue. The measurement adjusts non-taxable income to an equivalent pre-tax basis. Royal Bank is the only bank not to provide such data because, in its case, the difference from gross revenue is not material. If Scotia’s efficiency ratio is calculated using tax-adjusted revenue, it comes in lower than Royal Bank’s for the first six months, at 55.6% rather than 57.4%.
Another measure is amortization of intangibles, an item in non-interest expenses except in the case of CIBC. This is not an operating expense. For most banks, it’s a small item but for TD Bank Financial Group, it’s large. If it is excluded, TD’s efficiency ratio for the first six months is 65.3%, rather than 70% on a tax-adjusted revenue basis.

There are also unusual or non-recurring items. Analysts usually exclude items that they judge are not part of normal business or not under the control of management. It must be remembered, however, that there are also differences in the ways results are presented in which no adjustments can be made, says Neal Oswald, leader of PricewaterhouseCoopers’ banking and capital markets advisory practice in Toronto.
One bank may put an item in its expenses while another nets it out of revenue. There may also be differences in how aggressively they amortize or capitalize costs.

The bottom line is that you need to pay attention to the mix of business in each bank when making cross-bank comparisons. As Bilodeau says, “Focus on trends within each bank, from one quarter to the next.” IE