1. Chapter Thirteen
Depository Institutions’ Financial Statements and Analysis

2. Why Evaluate Performance of Depository Institutions (DIs)?
DIs are unique in
the special services they perform (e.g., assistance in the implementation of monetary policy)
the level of regulatory attention they receive
the types of assets and liabilities they hold
Managers, stockholder, depositors, regulators, and other parties use performance, earnings, and other measures obtained from financial statements to evaluate which DI stocks they will purchase

3. Financial Statements of Commercial Banks
Report of condition - balance sheet of a commercial bank reporting information at a single point in time
Report of income - income statement of a commercial bank reporting revenues, expenses, net profit or loss, and cash dividends over a period of time
Retail bank - focuses on consumer banking relationships
Wholesale bank - focuses on commercial banking relationships

4. Assets Four major subcategories
cash and balances due from other depository institutions
vault cash, deposits at the Federal Reserve, deposits at other FIs, and cash items in the process of collection
investment securities
interest-bearing deposits at other FIs, fed funds sold, RPs, U.S. Treas. and agency securities, securities issued by states and political subdivisions, mortgage-backed securities, other debt and equity securities
loans and leases
other assets
premises and fixed assets, real estate owned, investments in unconsolidated subsidiaries, intangible assets, other fees receivable

5. Liabilities
NOW account - negotiable order of withdrawal account, similar to a demand deposit with minimum balance
MMDAs - money market deposit accounts with retail savings accounts and limited checking account
Other savings deposits - other than MMDAs
Retail CDs - time deposits with face value below $100,000
Wholesale CDs - time deposits with face value above $100, (continued)

6. Liabilities
Negotiable instrument - an instrument whose ownership can be transferred in the secondary market
Brokered deposits - wholesale CDs obtained through a brokerage house
Core deposits - deposits of the bank that are stable over short periods of time and thus provide a long-term funding source to a bank
Purchased funds - rate-sensitive funding sources of the bank

7. Equity Capital Preferred and common stock (listed at par value)
Surplus or additional paid-in capital
Retained earnings
Regulations require banks to hold a minimum level of equity capital to act as a buffer against losses from their on- and off-balance sheet assets (see Chapter 14)

8. Off-Balance-Sheet Assets and Liabilities
Contingent assets and liabilities that may affect the future status of the FIs balance sheet
OBS activities grouped into 5 major categories
Loan commitments - contractual commitment to loan to a firm a certain maximum amount at given interest rate terms
up-front fee - fee charged for making funds available through a loan commitment
back-end fee - fee charged on the unused component of a loan commitment (continued)

9. Commercial and Standby Letters of Credit
letters of credit - contingent guarantees sold by an FI to underwrite the trade or commercial performance of the buyer of the guarantee
standby letter of credit - guarantees issued to cover contingencies that are potentially more sever and less predictable than contingencies covered under trade-related or commercial letters of credit
Forward Purchases and Sales of When-Issued Securities
when-issued securities - commitments to buy or sell securities before they are issued
Loans Sold
loans that a bank originated and then sold to other investors that may be returned (with recourse) to the originating institution in the future
recourse - the ability to put an asset or loan back to the seller should the credit quality of that asset deteriorate
Derivative Contracts
futures, forward, swap, and option positions taken by the FI for hedging or other purposes

10. Income Statement Interest Income Interest Expenses Net Interest Income
Provision for Loan Losses
Noninterest Income
Noninterest Expense
Income before Taxes and Extraordinary Items
Income Taxes
Extraordinary Items
Net Income

11. The Direct Relationship between the Income Statement and the Balance Sheet
N M
NI =  rnAn -  rmLm - P + NII - NIE - T
n= m=1
where
NI = Bank’s net income
An = Dollar value of the bank’s nth asset
Lm = Dollar value of the bank’s mth liability
rn = Rate earned on the bank’s nth asset
rm = Rate paid on the bank’s mth liability
P = Provision for loan losses
NII = noninterest income earned, including OBS
NIE = noninterest expenses incurred
T = Bank’s taxes
N = number of assets the bank holds
M = number of liabilities the bank holds

12. Financial Statement Analysis Using a Return on Equity Framework
Time series analysis - analysis of financial statements
over a period of time
Cross-sectional analysis - analysis of financial
statements comparing one firm with others
Return on equity (ROE) - measures overall profit-
ability of the FI per dollar of equity
ROE = Net income  Total Assets
Total Assets Total equity capital
= ROA  EM

13. Return on Assets and Its Components
Return on Assets (ROA) - measures profit generated
relative to the FI’s assets
ROA = Net Income  Total operating income
Total operating income Total assets
= PM  AU

14. Profit Margin
Profit Margin (PM) - measures a bank’s ability to pay expenses and generate net income from interest and noninterest income
Interest expense ratio = Interest expense
Total operating income
Provision for loan loss ration = Provision for loan losses
Noninterest expense ratio = Noninterest expense
Tax Ratio = Income taxes

15. Asset Utilization
Asset utilization (AU) - measures the amount of interest/
noninterest income generated per dollar of total assets
AU = Total operating income = Interest Noninterest
Total assets income income
ratio ratio

16. Net Interest Margin
Net interest margin - interest income minus interest
expense divided by earning assets
Net
interest = Net interest income
margin Earning assets
= Interest income - Interest expense
Investment securities + Net loans and leases

17. Spread Spread - the difference between lending and deposit rates
spread = Interest income Interest expense
Earning assets Interest-bearing liabilities

18. Overhead Efficiency Overhead efficiency - a bank’s ability to generate
noninterest income to cover noninterest expenses
Overhead efficiency = Noninterest income
Noninterest expense