The economic profit (EP) and risk-adjusted return on capital (RAROC) figures are two of the fundamental and necessary metrics for correct development of the value-base management system BBVA has introduced.
For its calculation, the economic profit is used, obtained by making the following adjustments to the net attributable profit: substituting generic provisions with an allocation based on expected loss; adjusting variation in unrealized capital gains in the equity holdings portfolio; adjusting the difference between the market value of the Global Markets positions and their book value; and altering the capital gains of the Group’s equity holdings in subsidiary companies resulting from exchange differences. In 2009, these adjustments increased the profit €580 million, primarily due to the adjustment of unrealized capital gains (which was negative at the same time in 2008), making the economic benefit €4,790 million.
These calculations, whose evolution in the medium to long term are very useful for determining the intrinsic value of a business, may be temporarily distorted by market volatility. It is therefore important to calculate recurrent data, which is largely due to business with customers, and hence the truly manageable component in these metrics. Said data is obtained by excluding those business units whose earnings are affected by fluctuations in capital gains in their portfolios and, cycle-adjusted loss is included for the purposes of calculating expected loss. Thus, the recurrent economic profit in December stood at €4,626 million.
Economic profit is the result of multiplying average economic risk capital (ERC) over the period (€22,065 million as at December 31, 2009) by the percentage of the cost of capital, is then deducted. This cost is based on information drawn from analysts’ consensus. It is different for each area and business unit in the Group, being equivalent to the rate of return demanded by the market, in return on equity terms.
This is how economic profit (EP) is reached, which is up to €2,314 million in 2009, and the recurrent stands at €2,620 million. This, once again, reflects BBVA´s capacity to generate profit over and above the cost of capital employed and, therefore, economic value for the shareholder.
RAROC measures the return earned by each business unit adjusted to the risk it bears. Comparing the adjusted profit against the average economic risk capital (ERC) for the period gives the BBVA Group a RAROC of 21.7%, while its recurrent RAROC was 25.1%.