Post on 26-Feb-2018
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BANKBANK
MANAGEMENTMANAGEMENT
CHAPTER 3CHAPTER 3
ANALYZING BANKANALYZING BANK
FINANCIAL STATEMENTSFINANCIAL STATEMENTS
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INTRODUCTIONINTRODUCTION
2 most important financial statements for a banking2 most important financial statements for a banking
firm:firm:
Balance Sheet / Report of ConditionBalance Sheet / Report of Condition
Financial information comparing what a bankFinancial information comparing what a bankowns with what it owes and the ownership interestowns with what it owes and the ownership interest
of stockholdersof stockholders
Income Statement / Report of IncomeIncome Statement / Report of IncomeReflects the financial nature of banking as interestReflects the financial nature of banking as interest
on loans and investments represents the bulk ofon loans and investments represents the bulk of
revenuerevenue
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The Balance SheetThe Balance Sheet
ists the assets! liabilities and e"uit# capitalists the assets! liabilities and e"uit# capital
$owners% funds& held b# or invested in a bank$owners% funds& held b# or invested in a bank
or other financial firm on an# given dateor other financial firm on an# given date Basic balance sheet identit#:Basic balance sheet identit#:
Assets = Liabilities + Equity capitalAssets = Liabilities + Equity capital
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ContCont
'ssets'ssets Cash in the vault and deposits held at theCash in the vault and deposits held at the
other depositor# institutions $C&other depositor# institutions $C&
(overnment and private interest)bearing(overnment and private interest)bearingsecurities purchased in the open market $S&securities purchased in the open market $S&
oans and lease financings made availableoans and lease financings made available
to customers $&to customers $& *iscellaneous assets $*'&*iscellaneous assets $*'&
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ContCont
iabilitiesiabilities
+eposits made b# and owed to various+eposits made b# and owed to various
customers $+&customers $+&
,ondeposit borrowings of funds in the mone#,ondeposit borrowings of funds in the mone#
and capital markets $,+B&and capital markets $,+B&
-"uit# Capital-"uit# Capital
Represents long term funds the ownersRepresents long term funds the owners
contribute $-C&contribute $-C&
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ContCont
Therefore balance sheet identity canTherefore balance sheet identity can
also be pictred as!also be pictred as!
C+S+L+MA = +NB+ECC+S+L+MA = +NB+EC
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Cont"Cont"
Cash 'ssets $C& . designed to meet a bank%s need forCash 'ssets $C& . designed to meet a bank%s need forli"uidit#li"uidit#
+eposit withdrawal! loans and unepected or+eposit withdrawal! loans and unepected or
immediate cash needsimmediate cash needs
Securit# holdings $S& . backup source of li"uidit#Securit# holdings $S& . backup source of li"uidit#
and provide another source of incomeand provide another source of income
oans $& . made principall# to suppl# incomeoans $& . made principall# to suppl# income
*iscellaneous assets $*'& . dominated b# fied*iscellaneous assets $*'& . dominated b# fiedassets and investments in subsidiariesassets and investments in subsidiaries
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+eposits $+& . main source of funding for banks+eposits $+& . main source of funding for banks ,ondeposit borrowings $,+B& . mainl# to supplement,ondeposit borrowings $,+B& . mainl# to supplement
deposits and provide the additional li"uidit# that cashdeposits and provide the additional li"uidit# that cash
assets and securities cannot provideassets and securities cannot provide
-"uit# Capital $-C& . supplies the long term! relativel#-"uit# Capital $-C& . supplies the long term! relativel#
stable base of financial support upon which thestable base of financial support upon which the
financial firm will rel# to grow and to cover an#financial firm will rel# to grow and to cover an#
etraordinar# losses it incursetraordinar# losses it incurs
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'ssets $accumulated uses of funds&'ssets $accumulated uses of funds& *ade to generate income for its*ade to generate income for its
stockholders! pa# interest to its depositorsstockholders! pa# interest to its depositors
and compensate its emplo#ees for theirand compensate its emplo#ees for theirlabor and skilllabor and skill
iabilities and -"uit# capital $accumulatediabilities and -"uit# capital $accumulated
sources of funds&sources of funds& 0rovide the needed spending power to0rovide the needed spending power to
ac"uire assetsac"uire assets
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ContCont
1he balance sheet identit# can also be pictured1he balance sheet identit# can also be pictured
as:as:
'ccumulated uses 'ccumulated sources'ccumulated uses 'ccumulated sources
of fundsof funds of funds of funds
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Assets of the Ban#in$ %ir&Assets of the Ban#in$ %ir&
Cash and +ue from +epositor# InstitutionsCash and +ue from +epositor# Institutions 'lso referred as'lso referred asprimary reservesprimary reserves
1he first line of defense against customer deposit1he first line of defense against customer deposit
withdrawals and the most important funds to meetwithdrawals and the most important funds to meet
customers loan re"uestcustomers loan re"uest
Cash balances earn little or no interest incomeCash balances earn little or no interest income
-ample: cash held in the bank%s vault! deposits-ample: cash held in the bank%s vault! depositsplaced with other depositor# institutions! cash itemplaced with other depositor# institutions! cash item
in the process of collection and the banking firm%sin the process of collection and the banking firm%s
reserve account held with the central bankreserve account held with the central bank
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ContCont
Investment Securities: The Liquid PortionInvestment Securities: The Liquid Portion
i"uid Securit# 3oldings ) Second line of defense to meet demands fori"uid Securit# 3oldings ) Second line of defense to meet demands forcashcash *iddle ground between cash assets and loans*iddle ground between cash assets and loans -arning some income-arning some income 3eld mainl# for the ease with which the# can be converted into cash3eld mainl# for the ease with which the# can be converted into cash
on short noticeon short notice 4ften called secondar# reserves or referenced on regulator# reports as4ften called secondar# reserves or referenced on regulator# reports as
5available for sale65available for sale6 1#picall# include holdings of short)term government securities and1#picall# include holdings of short)term government securities and
privatel# issued mone# market securities! including interest)bearing timeprivatel# issued mone# market securities! including interest)bearing timedeposits held with other banking firms and commercial paperdeposits held with other banking firms and commercial paper
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Cont"Cont"
Investment Securities: 1he Income)(eneratingInvestment Securities: 1he Income)(enerating
0ortion0ortion Securities held primaril# for their epected rate ofSecurities held primaril# for their epected rate of
return or #ieldreturn or #ield
-ample: Bonds! notes and other securities-ample: Bonds! notes and other securities Investment securities can be divided into:Investment securities can be divided into:
1aable securities1aable securities
(overnment bonds and notes(overnment bonds and notes Securities issued b# various federal agenciesSecurities issued b# various federal agencies
Corporate bonds and notesCorporate bonds and notes
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Cont"Cont"
1a)eempt securities1a)eempt securitiesState and local government bondsState and local government bonds
Investment securities ma# be recorded on theInvestment securities ma# be recorded on the
books of a banking firm at their original costbooks of a banking firm at their original costor at market value! whichever is loweror at market value! whichever is lower
Recent trend in accounting rules for banking isRecent trend in accounting rules for banking is
toward current market values $replacingtoward current market values $replacinghistorical cost&historical cost&
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Cont"Cont"
1rading 'ccount 'ssets1rading 'ccount 'ssets Securities purchased to provide short)term profitsSecurities purchased to provide short)term profits
from short)term price movementsfrom short)term price movements
,ot included in the 5Securities6 item in the balance,ot included in the 5Securities6 item in the balance
sheetsheet
Reported as trading account assetsReported as trading account assets
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Cont"Cont" Federal Funds Sold and Reverse Repurchase 'greementsFederal Funds Sold and Reverse Repurchase 'greements
Includes mainl# temporar# loans made to other depositor#Includes mainl# temporar# loans made to other depositor#institutions! securities dealers! ma7or industrialinstitutions! securities dealers! ma7or industrialcorporationscorporations
Funds come from the reserves a bank has on deposit withFunds come from the reserves a bank has on deposit with
the federal reserve bank $or central bank&the federal reserve bank $or central bank& Repurchase agreements . banking firms ac"uire temporar#Repurchase agreements . banking firms ac"uire temporar#
title to securities owned b# the borrower and holds thosetitle to securities owned b# the borrower and holds thosesecurities as collateral until the loan is paid off $normall#securities as collateral until the loan is paid off $normall#after onl# a few da#s&after onl# a few da#s&
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ContCont
'oans and leases'oans and leases The lar$est asset ite&The lar$est asset ite& 'oan types!'oan types!
Co&&ercial and indstrial loansCo&&ercial and indstrial loans
Cons&er loans ( loans to indi)idalCons&er loans ( loans to indi)idal Real estate loansReal estate loans 'oans to other instittions'oans to other instittions %orei$n loans%orei$n loans
A$ricltral prodction loansA$ricltral prodction loans *ecrity loans*ecrity loans 'eases'eases
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ContCont
Loan lossesLoan losses
deducted from the amount of total (gross) loandeducted from the amount of total (gross) loanfigure.figure.
bans are allo!ed to build u" a reser#e forbans are allo!ed to build u" a reser#e forfuture loan losses$ called the allo!ance for loanfuture loan losses$ called the allo!ance for loanlosses (%&&) based on their recent loan'losslosses (%&&) based on their recent loan'losse"erience.e"erience.
the %&& is a contra'asset account$ !hichthe %&& is a contra'asset account$ !hich
re"resents an accumulated reser#e againstre"resents an accumulated reser#e against!hich loans declared to be uncollectible can be!hich loans declared to be uncollectible can becharged off.charged off.
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Cont"Cont"
his means that bad loans normall* do not affecthis means that bad loans normall* do not affect
current income.current income.
+hen a loan is considered uncollectible$ the+hen a loan is considered uncollectible$ the
accounting de"artment !ill !rite (charge) it offaccounting de"artment !ill !rite (charge) it off
the boos b* reducing the %&& account b* thethe boos b* reducing the %&& account b* the
amount of the uncollectible loan !hileamount of the uncollectible loan !hile
simultaneousl* decreasing the asset account forsimultaneousl* decreasing the asset account forgross loans.gross loans.
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Cont"Cont"
Specific and general reservesSpecific and general reserves 'llowance for loan losses $'& can be divided'llowance for loan losses $'& can be divided
into:into:
Specific reservesSpecific reservesSet aside to cover a specific loan problems orSet aside to cover a specific loan problems or
loans epected to be a problem or that representloans epected to be a problem or that represent
above)average riskabove)average risk
(eneral reserves(eneral reserves
1he remaining reserves in the loan)loss account1he remaining reserves in the loan)loss account
after deducted specific reservesafter deducted specific reserves
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Cont"Cont"
,onperforming $noncurrent& loans $,0&,onperforming $noncurrent& loans $,0&
Credits that no longer accrue interest income orCredits that no longer accrue interest income or
that have had to be restructured to accommodate athat have had to be restructured to accommodate a
borrower%s changed circumstancesborrower%s changed circumstances,0 . scheduled loan repa#ment which past due,0 . scheduled loan repa#ment which past due
for more than 89 da#sfor more than 89 da#s
ill be deducted from loan revenuesill be deducted from loan revenues
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Cont"Cont"
Bank premises and fied assetsBank premises and fied assets
(oodwill and other intangible assets(oodwill and other intangible assets
'll other assets'll other assets
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iabilities of the Banking Firmiabilities of the Banking Firm
+eposits+eposits ; ma7or t#pes of deposit; ma7or t#pes of deposit
,oninterest)bearing demand deposits / checking,oninterest)bearing demand deposits / checking
accountaccount
Savings depositsSavings deposits
,4 accounts,4 accounts
*one# market deposit accounts $**+'s&*one# market deposit accounts $**+'s&
1ime deposits1ime deposits
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Borro+in$s fro& NondepositBorro+in$s fro& Nondeposit
*orces*orces borrowings in the mone# market such as R-04s!borrowings in the mone# market such as R-04s!
B's! Bills of -change! and issuing commercialB's! Bills of -change! and issuing commercialpaper
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ContCont
E,ity capitalE,ity capital
1.1. ,hare ca"ital -,hare ca"ital - common and preferredcommon and preferred
stocksstocks
2.2. etained earningsetained earnings
3.3. /ontingenc* reser#e -/ontingenc* reser#e -protection againstprotection against
unforeseen lossesunforeseen losses
4.4. reasur* stoc -reasur* stoc - stock that has been retired.stock that has been retired.
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ASSETS:ASSETS:
Cash = due from financial institutionsCash = due from financial institutions
Investment securities Investment securities
1otal $gross& loans 1otal $gross& loans
'llowance for loan losses'llowance for loan losses $&$&
,et loans ,et loans 0remises = -"uipment 0remises = -"uipment
4ther assets4ther assets
TOTAL ASSETSTOTAL ASSETS
LIA!ILITIES+E"#IT$LIA!ILITIES+E"#IT$
Liabilities:Liabilities:
+eposits +eposits
Borrowed funds Borrowed funds
4ther liabilities 4ther liabilities
ong)term debt ong)term debt Equity:Equity:
Capital surplus Capital surplus
'ccumulated retained earnings'ccumulated retained earnings
TOTAL L + ETOTAL L + E
BALANCE SHEETBALANCE SHEET
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STATEMENT OF LOAN LOSSSTATEMENT OF LOAN LOSS
PROVISIONPROVISION
Beginning reserve for loan losses Beginning reserve for loan losses
> 0rovision for loan losses > 0rovision for loan losses
) oan losses during the #ear $&) oan losses during the #ear $&
> Recoveries from previous loan losses > Recoveries from previous loan losses
-nding reserve for loan losses-nding reserve for loan losses ??????
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Income StatementsIncome Statements
indicates the amount of revenue received and epensesindicates the amount of revenue received and epensesincurred over a specific period of time
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INCOME STATEMENT
*a7or epenses incurred in generating bank*a7or epenses incurred in generating bankrevenuerevenue::
i&i& Interest paid out to depositors $+&!Interest paid out to depositors $+&!
ii&ii& Interest owed on non)deposit borrowings $,+B&!Interest owed on non)deposit borrowings $,+B&!
iii&iii& Cost of e"uit# capital $-C&!Cost of e"uit# capital $-C&!iv&iv& Salaries! wages and benefits paid to bank emplo#eesSalaries! wages and benefits paid to bank emplo#ees
$SB&!$SB&!
v&v& 4verhead epenses associated with the bank%s ph#sical4verhead epenses associated with the bank%s ph#sical
plant $4&!plant $4&!
vi&vi& Funds set aside for possible loan losses $0&!Funds set aside for possible loan losses $0&!
vii&vii& 1aes owed $1&! and1aes owed $1&! and
viii&viii& *iscellaneous epenses $*-&
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ContCont
The di-erence bet+een all re)enesThe di-erence bet+een all re)enesand e.penses is net inco&e/and e.penses is net inco&e/
Net Income:Net Income:
Total re)ene 0 Total e.penseTotal re)ene 0 Total e.pense
ite&s ite&site&s ite&s
C tC t
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ContCont
Interest IncomeInterest Income
Interest and fees generated from loans account forInterest and fees generated from loans account formost bank revenues $normall# two)thirds or more ofmost bank revenues $normall# two)thirds or more of
the total&the total&
Followed in importance b#:Followed in importance b#: investment earnings from taable and ta eemptinvestment earnings from taable and ta eempt
securitiessecurities
Interest earned on federal funds loans andInterest earned on federal funds loans and
repurchase agreementsrepurchase agreements
Interest received on time deposits placed with otherInterest received on time deposits placed with other
banksbanks
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Cont"Cont"
Interest epensesInterest epenses the number one epense item for a bank is interest onthe number one epense item for a bank is interest on
its depositsits deposits
,et Interest Income,et Interest Income
man# banks subtract total interest epenses from totalman# banks subtract total interest epenses from total
interest income to #ieldinterest income to #ield net interest incomenet interest incomeor oftenor often
referred to as thereferred to as the interest margininterest margin! the gap between the! the gap between the
interest income and the interest cost
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ContCont
oan)oss -penseoan)oss -pense 'nother epense item that banks can deduct from'nother epense item that banks can deduct from
current income is known as thecurrent income is known as theprovision for possibleprovision for possible
loan lossesloan losses
1his provision account is reall# a noncash epense1his provision account is reall# a noncash epense
Its purpose is to shelter a portion of the bank%s currentIts purpose is to shelter a portion of the bank%s current
earnings from taes in order to help prepare for badearnings from taes in order to help prepare for bad
loansloans
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ContCont
,oninterest Income,oninterest Income Sources of income other than earnings from loans andSources of income other than earnings from loans and
securitiessecurities
,ormall# include fees earned from offering trust,ormall# include fees earned from offering trust
services! service charges on deposit accounts andservices! service charges on deposit accounts and
miscellaneous fees and charges for other bankmiscellaneous fees and charges for other bank
servicesservices
Recentl#! noninterest income $fee income& have beenRecentl#! noninterest income $fee income& have beentargeted b# bankers as a ke# source of future revenuestargeted b# bankers as a ke# source of future revenues
C tC t
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ContCont ,oninterest -penses,oninterest -penses
@e# noninterest epense items for banks are wages!@e# noninterest epense items for banks are wages!
salaries! and other personnel epensessalaries! and other personnel epenses
4thers are costs of maintaining bank properties and4thers are costs of maintaining bank properties and
rental fees on office space! bank furniture and e"uipment!rental fees on office space! bank furniture and e"uipment!
legal fees! paper and office supplies and repair costslegal fees! paper and office supplies and repair costs ,et Income,et Income
,et income is e"ual to the income that a firm has after,et income is e"ual to the income that a firm has after
subtracting costs and epenses from the total revenue
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I,C4*- S1'1-*-,1I,C4*- S1'1-*-,1
Interest income Interest income
) Interest epense) Interest epense $&$&
%ET I%TE&EST I%'O(E %ET I%TE&EST I%'O(E
,on interest income ,on interest income
) ,on interest epense) ,on interest epense $&$&
%ET %O% I%TE&EST I%'O(E %ET %O% I%TE&EST I%'O(E
OPE&ATI%) P&O*IT OPE&ATI%) P&O*IT
P&O,ISIO% *O& LOA% LOSSES -. P&O,ISIO% *O& LOA% LOSSES -.
P&O*IT !E*O&E TA P&O*IT !E*O&E TA
TA -. TA -.
%ET I%'O(E %ET I%'O(E
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4ff)Balance Sheet in Banking4ff)Balance Sheet in Banking
Fee)based activities offered b# banking institutions
that normall# do not show up on the balance sheet
Recentl#! banks have converted man# of their
customer services into fee)generating transactions thatare not recorded on their balance sheets
0rominent eamples of these off)balance sheet items
include:
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ContCont
Standb# credit agreementsStandb# credit agreementsBank pledges to guarantee repa#ment ofBank pledges to guarantee repa#ment of
a customer%s loan received from a thirda customer%s loan received from a third
part#part#Interest rate swapsInterest rate swaps
' bank promises to echange interest' bank promises to echange interest
pa#ments on debt securities with anotherpa#ments on debt securities with anotherpart#part#
ContCont
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ContCont Financial futures and option interest)rate contractsFinancial futures and option interest)rate contracts
' bank agrees to deliver or to take deliver# of' bank agrees to deliver or to take deliver# ofsecurities from another part# at a guaranteed pricesecurities from another part# at a guaranteed price
oan commitmentsoan commitments
' bank pledges to lend up to a certain amount of' bank pledges to lend up to a certain amount of
funds until the commitment maturesfunds until the commitment matures
Foreign echange rate contractsForeign echange rate contracts
' bank agrees to deliver or accept deliver# of' bank agrees to deliver or accept deliver# of
foreign currenciesforeign currencies
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Cont"Cont"
TThe problems with these off)balance)sheethe problems with these off)balance)sheet
transactions is that the# often epose a banktransactions is that the# often epose a bankto added risk even though the# ma# not showto added risk even though the# ma# not show
up in conventional bank condition reports
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4ther Aseful Bank Financial4ther Aseful Bank Financial
StatementsStatements
1wo useful sources of financial information to1wo useful sources of financial information to
supplement the information provided on thesupplement the information provided on the
balance sheet and the income statement:balance sheet and the income statement:
Funds flow or sources and uses of fundsFunds flow or sources and uses of funds
statementstatement
Capital account statement or stockholders%Capital account statement or stockholders%
e"uit#e"uit#
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Sources and Ases of Funds StatementSources and Ases of Funds Statement
Ans+er t+o ,estions!Ans+er t+o ,estions! 1here did the fnds a ban# sed o)er a1here did the fnds a ban# sed o)er a
certain period of ti&e co&e fro&2certain period of ti&e co&e fro&2 3o+ +ere those fnds tili4ed23o+ +ere those fnds tili4ed2
It is based pon the follo+in$It is based pon the follo+in$relationships!relationships!
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Funds provided to the bank Funds provided to the bank
over a specific period of timeover a specific period of time
Fund used b# the bankFund used b# the bank
during a specific period ofduring a specific period of
timetime
Fund provided fromFund provided from
operations > +ecreases inoperations > +ecreases inbank assets > Increases inbank assets > Increases in
bank liabilitiesbank liabilities
+ividends paid out to+ividends paid out to
Stockholders > IncreasesStockholders > Increasesinin
bank assets > +ecreases inbank assets > +ecreases inbank liabilitiesbank liabilities
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And5 of corseAnd5 of corse
%nds pro)ided to the 6 %nds sed%nds pro)ided to the 6 %nds sed
by theby the
ban# o)er a speci7c ban# drin$ban# o)er a speci7c ban# drin$
thethe
ti&e period sa&e ti&eti&e period sa&e ti&e
periodperiod
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The 'apital Account Statement /The 'apital Account Statement /
Statement o0 Stoc1holders2 EquityStatement o0 Stoc1holders2 Equity
1he financial report reveal changes in the all)important1he financial report reveal changes in the all)importantcapital account! showing how the owners% investmentcapital account! showing how the owners% investmentof funds in the bank has changed over timeof funds in the bank has changed over time
Stockholders% e"uit# represents a cushion of financialStockholders% e"uit# represents a cushion of financialstrength for the bank that can be used to absorb lossesstrength for the bank that can be used to absorb lossesand protect the depositors and other creditors! changesand protect the depositors and other creditors! changesin the bank%s capital account are closel# followed b#in the bank%s capital account are closel# followed b#
regulators and large depositorsregulators and large depositors
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ContCont
Bank anal#sts look closel# at these statements to makeBank anal#sts look closel# at these statements to makesure that the bank%s capital account is still growing fastsure that the bank%s capital account is still growing fast
enough to keep up with the growth of its assetsenough to keep up with the growth of its assets
$especiall# loans&