Presentation is loading. Please wait.

Presentation is loading. Please wait.

Bank Financial Statements & Operations Copyright 2014 Diane Scott Docking 1.

Similar presentations


Presentation on theme: "Bank Financial Statements & Operations Copyright 2014 Diane Scott Docking 1."— Presentation transcript:

1 Bank Financial Statements & Operations Copyright 2014 Diane Scott Docking 1

2 2 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

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

4 The Bank Balance Sheet Flow of funds (tab down to commercial banks) 4 Copyright 2014 Diane Scott Docking

5 C + S + L + MA = D + NDB + EC C=Cash Assets S=Security Holdings L=Loans MA=Miscellaneous Assets D=Deposits NDB=Non Deposit Borrowings EC= Equity Capital Copyright 2014 Diane Scott Docking 5

6 6 To Increase a Bank’s Account: Debit Credit Asset Liability Income Capital Expense

7 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 7

8 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 8

9 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 9

10 Security Classification Recorded At Balance Sheet Reporting Income Statement Effect Copyright 2014 Diane Scott Docking 10 Trading Cost Unrealized gain/loss recognized in _____ HTM AFS Cost Unrealized gain/loss recognized in _________________ Gain/loss recognized when _____________

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

12 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 12

13 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 13

14 Problem: Loan Loss Reserves (cont.) LLR a/c (in millions) Beginning Balance 12/31/2xx1 + Provision - Charge-offs + Recoveries Ending Balance 12/31/2XX2 Copyright 2014 Diane Scott Docking 14 BB = 2 – – 3.5 = __________ The Expense

15 Problem: Loan Charge-offs Sycamore Bank’s allowance for loan losses from its balance sheet for the years ending 2XX1 and 2XX2 is: 12/31/2XX112/31/2XX2 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 15

16 Problem: Loan Charge-offs (cont.) LLR a/c Beginning Balance 12/31/2xx1 + Provision - Net Charge-offs Ending Balance 12/31/2XX2 Copyright 2014 Diane Scott Docking 16 Net Charge-offs = – = ______

17 Miscellaneous Assets Net Premises and Equipment OREO Goodwill and Other Intangibles Other Miscellaneous Assets Copyright 2014 Diane Scott Docking 17

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

19 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 19

20 Equity Capital Accounts ____________________ Stock Listed at par ____________________ Stock Ownership interest in the bank. Listed at par ____________________ 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 20

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

22 Copyright 2014 Diane Scott Docking 22 Off-Balance-Sheet Activities 1. Loan sales (secondary loan participation) 2. Fee income from Foreign exchange trades for customers Servicing mortgage-backed securities Guarantees of debt Backup lines of credit 3. Trading Activities and Risk Management Techniques 1. Financial futures and options 2. Foreign exchange trading 3. Interest rate swaps All these activities involve risk and potential conflicts

23 Banks' Income Statement 23 Copyright 2014 Diane Scott Docking

24 Banks' Income Statement (cont.) 24 Copyright 2014 Diane Scott Docking

25 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 25 Interest Income Interest Expenses

26 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 26 Noninterest Income Noninterest Expenses

27 Problem: Bank Income Statements You know the following figures: Total interest income $140 Provision for loan losses$5 Total interest expense $100 Income taxes$5 Total noninterest income $ 15 Increases in bank’s undivided profits$6 Total noninterest expenses $ 35 Calculate the following items: a) Net interest incomee) Total operating revenues b) Net noninterest incomef) Total operating expenses c) Pretax net operating incomeg) Dividends paid to common stockholders d) Net income after taxes Copyright 2014 Diane Scott Docking 27

28 Solution: Bank Income Statements Calculate the following items: a) Net interest income b) Net noninterest income c) Pretax net operating income Copyright 2014 Diane Scott Docking 28 = 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 = _______

29 Solution: Bank Income Statements (cont.) d) Net income after taxes e) Total operating revenues f) Total operating expenses g) Dividends paid to common stockholders Copyright 2014 Diane Scott Docking 29 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 = _____

30 Problem: Bank Balance Sheets You know the following figures: Gross loans$275Miscellaneous assets$ 38 Cash and due from banks$ 9Nondeposit borrowings$ 20 Investment securities$ 36Allowance for loan losses$ 5 Trading account securities$ 2Preferred stock$ 3 Goodwill and other intangibles$ 3Common stock$ 5 Other real estate owned$ 4Surplus$ 19 Bank premises and equipment, gross$ 34Total liabilities$375 Bank premises and equipment, net$ 29Total equity capital$ 39 Calculate the following items: a) Total assetsd) Accumulated Depreciation b) Net loanse) Total deposits c) Undivided profitsf) Fed funds sold Copyright 2014 Diane Scott Docking 30

31 Solution: Bank Balance Sheets Calculate the following items: a) Total assets b) Net loans c) Undivided profits d) Accumulated Depreciation Copyright 2014 Diane Scott Docking 31 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 = ______

32 Solution: Bank Balance Sheets Calculate the following items: e) Total deposits f) Fed funds sold Copyright 2014 Diane Scott Docking 32 Total Liabilities – Nondeposit Borrowings = 375 – 20 = _______ Total Assets: Cash and Due from Banks$ 9 Federal Funds Sold ? Investments 36 Gross Loans 275 Less: Allowance for Loan Losses -5 Bank Premises and Equipment, Net 29 Miscellaneous Assets 38 Trading Account Securities 2 Other Real Estate Owned 4 Goodwill and other Intangibles 3 Subtotal 391 Less Total Assets 414 Difference = Fed Funds Sold**____

33 Copyright 2014 Diane Scott Docking 33 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.

34 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 34

35 Recent Trends in Bank Performance Measures ROA = Net Profits/ Assets; ROE = Net Profits/ Equity Capital; NIM = [Interest Income – Interest Expenses]/ Assets 35 Copyright 2014 by Diane S. Docking

36 36 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?

37 Copyright 2014 by Diane S. Docking 37 Solution to Example: Bank Accounting T-account Analysis: Deposit of $100 cash into First National Bank Dr) Vault Cash$100 Cr) DDA$100

38 Copyright 2014 by Diane S. Docking 38 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?

39 Copyright 2014 by Diane S. Docking 39 Solution to Example 2: Bank Accounting Deposit of $100 check When check clears:

40 Copyright 2014 by Diane S. Docking 40 Example 3: 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 to record this transaction assuming the bank must keep 10% of every deposit as Required Reserves?

41 Copyright 2014 by Diane S. Docking 41 Solution to Example 3: Bank Accounting T-account Analysis: Deposit of $100 cash into First National Bank

42 Copyright 2014 by Diane S. Docking 42 Example 4: Bank Accounting 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.

43 Copyright 2014 by Diane S. Docking 43 Solution to Example 4: Bank Accounting T-account Analysis: Loan of $90 to Mary Smith

44 Copyright 2014 by Diane S. Docking 44 General Principles of Bank Management The bank has four primary concerns when managing assets: 1. Liquidity management 2. Asset management Managing credit risk Managing interest-rate risk 3. Liability management 4. Managing capital adequacy

45 Copyright 2014 by Diane S. Docking 45 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.

46 Copyright 2014 by Diane S. Docking 46 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.

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

48 Copyright 2014 by Diane S. Docking 48 Example: Bank Liquidity Management – No Excess Reserves (cont.) With 10% reserve requirement, bank has $9 million reserve shortfall What must it do?????? Assume $10 million is withdrawn from various deposit accounts. The Bank Balance Sheet is now:

49 Copyright 2014 by Diane S. Docking 49 Example: Bank Liquidity Management – No Excess Reserves (cont.) 1. Borrow $9 million from other banks either directly or in the Fed Funds market.

50 Copyright 2014 by Diane S. Docking 50 Example: Bank Liquidity Management – No Excess Reserves (cont.) 2. Sell $9 million in Securities (AFS)

51 Copyright 2014 by Diane S. Docking 51 Example: Bank Liquidity Management – No Excess Reserves (cont.) 3. Borrow $9 million from the Fed Discount Window

52 Copyright 2014 by Diane S. Docking 52 Example: Bank Liquidity Management – No Excess Reserves (cont.) 4. Call in or sell off loans.

53 Copyright 2014 by Diane S. Docking 53 Asset Management Asset Management: the attempt to earn the highest possible return on assets while minimizing the risk. 1. Get borrowers with low default risk, paying high interest rates 2. Buy securities with high return, low risk 3. Diversify 4. Manage liquidity

54 Copyright 2014 by Diane S. Docking 54 Liability Management Liability Management: managing the source of funds, from deposits, to CDs, to other debt. 1. Important since 1960s 2. No longer primarily depend on deposits 3. When see loan opportunities, borrow or issue CDs to acquire funds

55 Copyright 2014 by Diane S. Docking 55 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.

56 Copyright 2014 by Diane S. Docking 56 Example: Capital Adequacy Management 1. Bank capital is a cushion that prevents bank failure. For example, consider these two banks: Capital/TA=10% Capital/TA=4%

57 Copyright 2014 by Diane S. Docking 57 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.

58 Copyright 2014 by Diane S. Docking 58 Example: Capital Adequacy Management (cont.) Impact of $5 million loan loss. Capital/TA=5.26% Capital/TA= -1.05%

59 Copyright 2014 by Diane S. Docking 59 Capital Adequacy Management So, why don’t banks hold want to hold a lot of capital?? 2. 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 

60 Copyright 2014 by Diane S. Docking 60 Capital Adequacy Management 3. Tradeoff between safety (high capital) and ROE 4. Banks also hold capital to meet capital requirements (more on this in Chapter 13).

61 Copyright 2014 by Diane S. Docking 61 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)

62 Copyright 2014 by Diane S. Docking 62 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)


Download ppt "Bank Financial Statements & Operations Copyright 2014 Diane Scott Docking 1."

Similar presentations


Ads by Google