1. Bank Financial Statements & Operations Copyright 2013 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 2013 Diane Scott Docking 3 5-3

4. The Bank Balance Sheet Flow of funds (tab down to commercial banks) http://www.federalreserve.gov/releases/z1/current/z1r-4.pdf http://www.federalreserve.gov/releases/z1/current/z1r-4.pdf 4 Copyright 2013 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 2013 Diane Scott Docking 5

6. Copyright 2013 by Diane S. Docking 6 To Increase a Banks Account: Debit Credit

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 2013 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 2013 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 2013 by Diane S. Docking 9

10. Security Classification Recorded At Balance Sheet Reporting Income Statement Effect Copyright 2013 by Diane S. 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 2013 Diane Scott Docking 11 5-11

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 2013 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 banks balance sheet reserve for loan losses was $2 million. What was the banks apparent reserve for loan losses at the end of the prior year (December 31, 2XX1)? Copyright 2013 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 2013 Diane Scott Docking 14 BB = 2 – 1.75 + 5 – 3.5 = __________ The Expense

15. Problem: Loan Charge-offs Sycamore Banks 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 2013 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 2013 Diane Scott Docking 16 Net Charge-offs = 49.235 + 15.00 – 55.335 = ______

17. Miscellaneous Assets Net Premises and Equipment OREO Goodwill and Other Intangibles Other Miscellaneous Assets Copyright 2013 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 2013 Diane Scott Docking 18 5-18

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 2013 by Diane S. 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 2013 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 2013 Diane Scott Docking 21 5-21

22. Copyright 2013 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 2013 Diane Scott Docking

24. Banks' Income Statement (cont.) 24 Copyright 2013 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 2013 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 2013 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 banks 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 2013 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 2013 by Diane S. 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 2013 by Diane S. Docking 29 Pretax net operating income – Taxes = 15 – 5 = ______ Interest Income + Noninterest Income =140 + 15 = ______ Interest Expenses + Noninterest Expenses + PLL = 100 + 35 + 5 = _______ 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 2013 by Diane S. Docking 30

31. Solution: Bank Balance Sheets Calculate the following items: a) Total assets b) Net loans c) Undivided profits d) Accumulated Depreciation Copyright 2013 by Diane S. Docking 31 Total Liabilities + Total Equity Capital = 375 + 39 = ______ 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 2013 by Diane S. 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 2013 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 2013 Diane Scott Docking 34