Economic profit and risk-adjusted return on economic capital

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 losses; accounting the changes in unrealized capital gains on the holding portfolios; applying the difference between all the accounting positions of Global Markets and their market value; and reflecting changes in the total net-asset value due to exchange-rate variations on holdings in Group companies. In 2010, these adjustments amounted to €2,863m of book value, above all due to the adjustment of changes in the value, so the adjusted profit was €1,743m.

These calculations, whose evolution in the medium to long term is 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 accumulated recurrent adjusted profit in 2010 was €4,981m, an increase of 7.7% on the figure for 2009.

From the adjusted profit a subtraction is made which comes from multiplying the average economic risk capital or ERC for the period (€24,322m as of December 31, 2010) by the percentage cost of capital. 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 gives the economic profit, which amounted to –€1,238m in the year. However, the recurrent economic profit stood at €2,618m, once more reflecting the degree to which BBVA generates profits in excess of the cost of capital employed, and thus economic value for its shareholders.

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 7.2%, while its recurrent RAROC was 24.9%.

Economic profit and risk-adjusted return on economic capital

(Million euros)


  2010 D% 2009 2008
NET ATTRIBUTABLE PROFIT 4,606 9.4 4,210 5,020
Adjustments (2,863) n.m. 579 (3,241)
ADJUSTED NET ATTRIBUTABLE PROFIT (A) 1,743 (63.6) 4,789 1,779
Average economic risk capital (ERC) (B) 24,322 10.2 22,078 19,614
RECURRENT RAROC (%) 24.9   25.1 30.0
ERC x cost of capital (C) 2,981 20.4 2,476 2,053
ECONOMIC PROFIT (EP) = (A) - (C) (1,238) n.m. 2,313 (275)
RECURRENT ECONOMIC PROFIT 2,618 (0.1) 2,620 3,402