Bank Financial Statements & Operations

Name: Bank Financial Statements & Operations
Uploaded: 2017-10-19T23:59:13+00:00
Duration: PTM27S5
Channel: Israel Scotch
Description: Bank Financial Statements & Operations

Bank Financial Statements & Operations
Copyright 2014 Diane Scott Docking

Learning Objectives Examine how commercial banking is conducted to earn the highest profits possible. Topics include: The Bank Balance Sheet The Bank Income Statement Off-Balance Sheet Activities General Measuring Bank Performance Copyright 2014 Diane Scott Docking

Bank Financial Statements
5-3 Bank Financial Statements Report of Condition – Balance Sheet Report of Income – Income Statement Copyright 2014 Diane Scott Docking

To Increase a Bank’s Account:
Debit Credit Asset Liability Income Capital Expense Copyright 2014 Diane Scott Docking

Cash Assets Account is called Cash and Due from Banks Includes: Vault Cash Deposits with Other Banks Cash Items in Process of Collection Reserve Account with Fed Sometimes Called Primary Reserves Copyright 2014 Diane Scott Docking

Securities Holdings Money Market Securities (sometimes called Secondary Reserves) Investment Securities Taxable Securities Tax-Exempt Securities Trading Account Securities Held for Resale Only Valued at Market Value Copyright 2014 Diane Scott Docking

Bank Investments and FASB 115
Following FASB 115 a bank, at purchase, must designate the objective behind buying investment securities as either: Copyright 2014 Diane Scott Docking

Security Classification
Recorded At Balance Sheet Reporting Income Statement Effect Unrealized gain/loss recognized in _____ Trading Cost Gain/loss recognized when _____________ HTM Cost Unrealized gain/loss recognized in _________________ AFS Cost Copyright 2014 Diane Scott Docking

Federal Funds Sold and Reverse Repurchase Agreements
5-11 Federal Funds Sold and Reverse Repurchase Agreements A Type of Loan Account Generally Overnight Loans Federal Funds Sold - Funds Come from the Deposits at the Federal Reserve Reverse Repurchase Agreements – Bank Takes Temporary Title to Securities Owned by Borrower Copyright 2014 Diane Scott Docking

Loan Accounts Gross Loans = Sum of All Loans - Allowance for Possible Loan Losses Contra Asset Account For Potential Future Loan Losses - Unearned Discounts = Net Loans Nonperforming Loans Copyright 2014 Diane Scott Docking

Problem: Loan Loss Reserves
Portland Bank made a provision for loan losses of $3.5 million, took loan charge-offs of $5 million, and had recoveries of $1,750,000 during the year 2XX2. At December 31, 2XX2, the bank’s balance sheet reserve for loan losses was $2 million. What was the bank’s apparent reserve for loan losses at the end of the prior year (December 31, 2XX1)? Copyright 2014 Diane Scott Docking

Problem: Loan Loss Reserves (cont.)
LLR a/c (in millions) Beginning Balance 12/31/2xx1 + Provision - Charge-offs + Recoveries Ending Balance 12/31/2XX2 The Expense BB = 2 – – 3.5 = __________ Copyright 2014 Diane Scott Docking

Problem: Loan Charge-offs
Sycamore Bank’s allowance for loan losses from its balance sheet for the years ending 2XX1 and 2XX2 is: 12/31/2XX1 12/31/2XX2 Allowance for loan losses $49,235,000 $55,335,000 During the year 2XX2, Sycamore Bank took a provision for loan losses charge of $15 million against its income. Determine the apparent amount of net loan charge-offs during 2XX2. Copyright 2014 Diane Scott Docking

Problem: Loan Charge-offs (cont.)
LLR a/c Beginning Balance 12/31/2xx1 + Provision - Net Charge-offs Ending Balance 12/31/2XX2 Net Charge-offs = – = ______ Copyright 2014 Diane Scott Docking

5-18 Deposit Accounts Non interest-Bearing Demand Deposits Savings Deposits Now Accounts Money Market Deposit Accounts (MMDA) Time Deposits Core vs. Volatile Deposits Copyright 2014 Diane Scott Docking

Nondeposit Borrowings
Fed Funds Purchased/Borrowed Securities Sold under Agreements to Repurchases (Repurchase Agreements) Acceptances Outstanding Eurocurrency Borrowings Due to Fed (Discount Loans) Long-term Debt Notes and Debentures notes and bonds with maturities in excess of one year. Stock Other Liabilities Copyright 2014 Diane Scott Docking

Equity Capital Accounts
____________________ Stock Listed at par Ownership interest in the bank. ____________________ represents the amount of proceeds received by the bank in excess of par when it issued the stock ______________________ Retained Earnings Treasury Stock Contingency Reserve Reserves for Copyright 2014 Diane Scott Docking

Off-Balance-Sheet Items
5-21 Off-Balance-Sheet Items Unused Commitments Standby Credit Agreements Derivative Contracts Futures Contracts Options Swaps OBS Transactions Exposes a Firm to Counterparty Risks Copyright 2014 Diane Scott Docking

Off-Balance-Sheet Activities
Loan sales (secondary loan participation) Fee income from Foreign exchange trades for customers Servicing mortgage-backed securities Guarantees of debt Backup lines of credit Trading Activities and Risk Management Techniques Financial futures and options Foreign exchange trading Interest rate swaps All these activities involve risk and potential conflicts Copyright 2014 Diane Scott Docking

Banks' Income Statement

Banks' Income Statement (cont.)

Net Interest Income = Interest Income - Interest Expenses
Interest on: Loans Taxable Securities Tax-exempt Securities Deposits held at other institutions, Other Interest Income Interest on: Deposits Short Term Debt Long Term Debt Copyright 2014 Diane Scott Docking

Net Noninterest Income = Noninterest Income - Noninterest Expenses
Fee income Service Charge on Customer Deposits Trust Department Income Trading account gains and fees Other Operating Income Wages, Salaries, and benefits Other Personnel Expenses Net Occupancy Expenses rent and depreciation on equipment and premises Other Operating Expenses Utilities, advertising, deposit insurance premiums, etc. Copyright 2014 Diane Scott Docking

Problem: Bank Income Statements
You know the following figures: Total interest income $ Provision for loan losses $5 Total interest expense $ Income taxes $5 Total noninterest income $ Increases in bank’s undivided profits $6 Total noninterest expenses $ 35 Calculate the following items: a) Net interest income e) Total operating revenues b) Net noninterest income f) Total operating expenses c) Pretax net operating income g) Dividends paid to common stockholders d) Net income after taxes Copyright 2014 Diane Scott Docking

Solution: Bank Income Statements
Calculate the following items: a) Net interest income b) Net noninterest income c) Pretax net operating income = Total Interest Income – Total Interest Expense = 140 – 100 = _____ = Total Noninterest Income – Total Noninterest Expense = 15 – 35 = _______ = Net Interest Income + Net Noninterest Income + PLL = 40 – 20 – 5 = _______ Copyright 2014 Diane Scott Docking

Solution: Bank Income Statements (cont.)
d) Net income after taxes e) Total operating revenues f) Total operating expenses g) Dividends paid to common stockholders Pretax net operating income – Taxes = 15 – 5 = ______ Interest Income + Noninterest Income = = ______ Interest Expenses + Noninterest Expenses + PLL = = _______ Net Income After Taxes – Increase in Undivided Profits = 10 – 6 = _____ Copyright 2014 Diane Scott Docking

Problem: Bank Balance Sheets
You know the following figures: Gross loans $275 Miscellaneous assets $ 38 Cash and due from banks $ 9 Nondeposit borrowings $ 20 Investment securities $ 36 Allowance for loan losses $ 5 Trading account securities $ 2 Preferred stock $ 3 Goodwill and other intangibles $ 3 Common stock $ 5 Other real estate owned $ 4 Surplus $ 19 Bank premises and equipment, gross $ 34 Total liabilities $375 Bank premises and equipment, net $ 29 Total equity capital $ 39 Calculate the following items: a) Total assets d) Accumulated Depreciation b) Net loans e) Total deposits c) Undivided profits f) Fed funds sold Copyright 2014 Diane Scott Docking

Solution: Bank Balance Sheets
Calculate the following items: a) Total assets b) Net loans c) Undivided profits d) Accumulated Depreciation Total Liabilities + Total Equity Capital = = ______ Gross Loans – ALL = 275 – 5 = _____ Total Equity Capital – Preferred Stock – Common Stock – Surplus= = 39 – 3 – 5 – 19 = ______ PPE, gross – PPE, net = 34 – 29 = ______ Copyright 2014 Diane Scott Docking

Solution: Bank Balance Sheets
Calculate the following items: e) Total deposits f) Fed funds sold Total Liabilities – Nondeposit Borrowings = 375 – 20 = _______ Total Assets: Cash and Due from Banks $ 9 Federal Funds Sold ? Investments Gross Loans 275 Less: Allowance for Loan Losses Bank Premises and Equipment, Net 29 Miscellaneous Assets Trading Account Securities Other Real Estate Owned Goodwill and other Intangibles Subtotal 391 Less Total Assets 414 Difference = Fed Funds Sold** ____ Copyright 2014 Diane Scott Docking

Measuring Bank Performance
As, much like any firm, ratio analysis is useful to measure performance and compare performance among banks. The following slide shows both calculations and historical averages for key bank performance measures. Copyright 2014 Diane Scott Docking

ROE can be misleading If ROE is high - may mean there is not enough capital and this is not good If ROE is low - May mean a lot of capital. This is okay, but bank may be inefficient. Copyright 2014 Diane Scott Docking

Recent Trends in Bank Performance Measures
ROA = Net Profits/ Assets; ROE = Net Profits/ Equity Capital; NIM = [Interest Income – Interest Expenses]/ Assets Copyright 2014 by Diane S. Docking

Example: Bank Accounting
Jason opens a savings account at First National Bank with $100 cash. What are the accounting entries made by the bank to record this transaction? Copyright 2014 by Diane S. Docking

Solution to Example: Bank Accounting
T-account Analysis: Deposit of $100 cash into First National Bank Dr) Vault Cash $100 Cr) DDA $100 Copyright 2014 by Diane S. Docking

Example 2: Bank Accounting
Ruthie has a checking account at First National Bank. She deposits a $100 check from her mom. Her mom’s checking account is at the Second National Bank. What are the accounting entries made by First National Bank and Second National Bank to record this transaction? Copyright 2014 by Diane S. Docking

Solution to Example 2: Bank Accounting
Deposit of $100 check When check clears: Copyright 2014 by Diane S. Docking

Ruthie has a checking account at First National Bank. She deposits a $100 check from her mom. Her mom’s checking account is at the Second National Bank. What are the accounting entries made by First National Bank to record this transaction assuming the bank must keep 10% of every deposit as Required Reserves? Copyright 2014 by Diane S. Docking

Assume, after the transactions in Example 3, that First National Bank makes a $90 loan to Mary Smith. What are the accounting entries made by First National Bank to record this transaction. Copyright 2014 by Diane S. Docking

General Principles of Bank Management
The bank has four primary concerns when managing assets: Liquidity management Asset management Managing credit risk Managing interest-rate risk Liability management Managing capital adequacy Copyright 2014 by Diane S. Docking

Example: Bank Liquidity Management –Excess Reserves
FNB Bank is required to keep 10% of deposits as Required Reserve. Below is their beginning Balance Sheet: NOTE: The Bank has $10 million required reserves and $10 million in excess reserves. Copyright 2014 by Diane S. Docking

Example: Bank Liquidity Management – Excess Reserves (cont.)
Assume $10 million is withdrawn from various deposit accounts. The Bank Balance Sheet is now: Now, Bank has $9 million in required reserves and $1 million in excess reserves. Copyright 2014 by Diane S. Docking

Example: Bank Liquidity Management – No Excess Reserves
FNB Bank is required to keep 10% of deposits as Required Reserve. Below is their beginning Balance Sheet: The Bank has No excess reserves. Copyright 2014 by Diane S. Docking

Example: Bank Liquidity Management – No Excess Reserves (cont.)
Assume $10 million is withdrawn from various deposit accounts. The Bank Balance Sheet is now: With 10% reserve requirement, bank has $9 million reserve shortfall What must it do?????? Copyright 2014 by Diane S. Docking

Asset Management Asset Management: the attempt to earn the highest possible return on assets while minimizing the risk. Get borrowers with low default risk, paying high interest rates Buy securities with high return, low risk Diversify Manage liquidity Copyright 2014 by Diane S. Docking

Liability Management Liability Management: managing the source of funds, from deposits, to CDs, to other debt. Important since 1960s No longer primarily depend on deposits When see loan opportunities, borrow or issue CDs to acquire funds Copyright 2014 by Diane S. Docking

Funds Management It’s important to understand that banks now manage both sides of the balance sheet together, whereas it was more separate in the past. Indeed, most banks now manage this via the asset-liability management (ALM) committee. This explains the increased use of CDs and loans over checkable deposits in recent decades. Copyright 2014 by Diane S. Docking

Example: Capital Adequacy Management
Bank capital is a cushion that prevents bank failure. For example, consider these two banks: Capital/TA=10% Capital/TA=4% Copyright 2014 by Diane S. Docking

Example: Capital Adequacy Management (cont.)
What happens if these banks make loans or invest in securities (say, subprime mortgage loans, for example) that end up losing money? Let’s assume both banks lose $5 million from bad loans. Copyright 2014 by Diane S. Docking

Example: Capital Adequacy Management (cont.)
Impact of $5 million loan loss. Capital/TA=5.26% Capital/TA= -1.05% Copyright 2014 by Diane S. Docking

Capital Adequacy Management
So, why don’t banks hold want to hold a lot of capital?? Higher is bank capital, lower is return on equity ROA = Net Profits/Assets ROE = Net Profits/Equity Capital EM = Assets/Equity Capital ROE = ROA  EM Capital , EM , ROE  Copyright 2014 by Diane S. Docking

Capital Adequacy Management
Tradeoff between safety (high capital) and ROE Banks also hold capital to meet capital requirements (more on this in Chapter 13). Copyright 2014 by Diane S. Docking

Managing Capital Strategies for Managing Capital: what should a bank manager do if she feels the bank is holding too much capital? Sell or retire stock Increase dividends to reduce retained earnings Increase asset growth via debt (like CDs) . Copyright 2014 by Diane S. Docking

Managing Capital Reversing these strategies will help a manager if she feels the bank is holding too little capital? Issue stock Decrease dividends to increase retained earnings Slow asset growth (retire debt) Copyright 2014 by Diane S. Docking

Bank Financial Statements & Operations

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