The Financial Statements of Banks and Their Principal Competitors
30
McGraw-Hill/Irwin 1-1 © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. CHAPTER FIVE (Three) The Financial Statements of Banks and Their Principal Competitors The purpose of this chapter is to The purpose of this chapter is to acquaint the students with the acquaint the students with the content, structure and purpose of content, structure and purpose of bank financial statements and to bank financial statements and to help managers understand how help managers understand how information from bank financial information from bank financial statements can be used as tools to statements can be used as tools to reveal how well their banks are reveal how well their banks are performing. performing.
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Transcript of The Financial Statements of Banks and Their Principal Competitors
McGraw-Hill/Irwin
1-1
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
CHAPTER FIVE(Three) The Financial Statements of
Banks and Their Principal Competitors
The purpose of this chapter is to acquaint the The purpose of this chapter is to acquaint the students with the content, structure and students with the content, structure and purpose of bank financial statements and to purpose of bank financial statements and to help managers understand how information help managers understand how information from bank financial statements can be used from bank financial statements can be used as tools to reveal how well their banks are as tools to reveal how well their banks are performing.performing.
McGraw-Hill/Irwin
1-2
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Financial Statements
Important Financial StatementsImportant Financial Statements Report of Condition Report of Condition –– Balance Sheet Balance Sheet Report of Income Report of Income –– Income Statement Income Statement Sources and Uses of Funds StatementSources and Uses of Funds Statement Statement of StockholdersStatement of Stockholders’’ Equity Equity
Reflect services offeredReflect services offered
Overall sizeOverall size
Analysis of Analysis of performanceperformance
McGraw-Hill/Irwin
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Report of ConditionThe Balance Sheet of a Bank Showing its Assets, Liabilities and Net WorthThe Balance Sheet of a Bank Showing its Assets, Liabilities and Net WorthAccounting Equation: Assets=Liabilities +Equity Capital Accounting Equation: Assets=Liabilities +Equity Capital (1)(1)
Accounting System: What a company owns and what it Accounting System: What a company owns and what it owesowes
AssetsAssets= Resources with future benefits that are = Resources with future benefits that are owned and controlled by a companyowned and controlled by a company
Examples: cash, supplies, equipment and Examples: cash, supplies, equipment and landland
LiabilitiesLiabilities= What a company owes to its = What a company owes to its nonowners nonowners (creditors)(creditors)
Examples: debt to a bank in the form of a Examples: debt to a bank in the form of a note note payable, accounts payable to payable, accounts payable to suppliessupplies
EquityEquity= owner’s claim on assets (Owner’s equity)= owner’s claim on assets (Owner’s equity)
McGraw-Hill/Irwin
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C + S + L + MA = D + NDB + EC C + S + L + MA = D + NDB + EC (2) (2)
Accumulated uses of bank funds= Accumulated uses of bank funds= Accumulated sources of bank funds Accumulated sources of bank funds
(3) (3)
McGraw-Hill/Irwin
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C + S + L + MA = D + NDB + EC
CC = = Cash AssetsCash Assets
S = Security HoldingsS = Security Holdings
L = LoansL = Loans
MA = Miscellaneous MA = Miscellaneous AssetsAssets
D = DepositsD = Deposits
NDB = Nondeposit NDB = Nondeposit Borrowings Borrowings
EC = Equity CapitalEC = Equity Capital
McGraw-Hill/Irwin
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Cash Assets (C)
Account is Called Cash and Deposits Due from Bank
Includes: Vault Cash Deposits with Other Banks Cash Items in Process of Collection(uncollected
checks) Reserve Account with the Federal Reserve/BB
Sometimes Called Primary ReservesPrimary ReservesObjective is to keep the size of this account as Objective is to keep the size of this account as small as possible as they earn little or no interest small as possible as they earn little or no interest incomeincome
McGraw-Hill/Irwin
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Security Holdings (S)
Money Market SecuritiesMoney Market Securities –– Secondary Secondary ReservesReserves:short-term govt. securities, interest-:short-term govt. securities, interest-bearing time deposit held with other banks etc.bearing time deposit held with other banks etc.
Investment SecuritiesInvestment Securities Taxable Securities: Govt. or corporate bonds and Taxable Securities: Govt. or corporate bonds and
notesnotes Nontaxable Securities: tax-exempt bonds and notesNontaxable Securities: tax-exempt bonds and notes
>>>Recorded in the BS at lower of cost or market>>>Recorded in the BS at lower of cost or market Trading Account SecuritiesTrading Account Securities
>Held for Resale Only>Held for Resale Only
>Valued at Market Value>Valued at Market Value
McGraw-Hill/Irwin
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© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Loan Accounts
Gross LoansGross Loans –– Sum of All Loans Sum of All Loans Allowance for Possible Loan LossesAllowance for Possible Loan Losses
Contra Asset AccountContra Asset Account For Potential Future Loan LossesFor Potential Future Loan Losses
Net LoansNet Loans Nonperforming Loans: Nonperforming Loans: Due more than Due more than
90 days90 days
McGraw-Hill/Irwin
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Miscellaneous Assets
Fed Funds Sold: Reserve soldSecurities Purchased Under
Agreement to Resell (Repurchase Agreements)
Customers’ Liabilities on AcceptancesNet Premises and EquipmentOther Miscellaneous Assets: Goodwill
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Deposit Accounts
Non interest-Bearing Demand DepositsNon interest-Bearing Demand Deposits Savings DepositsSavings Deposits: Bear the lowest rate of : Bear the lowest rate of
interestinterest Money Market Deposit Accounts (MMDA)Money Market Deposit Accounts (MMDA)::
>limited check>interest>notice for withdrawal>limited check>interest>notice for withdrawal Time Deposits (Certificate of Deposits [CDs])Time Deposits (Certificate of Deposits [CDs])
>fixed maturity>higher interest rates>>fixed maturity>higher interest rates>
McGraw-Hill/Irwin
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Nondeposit Borrowings
Fed Funds Purchased: Reserve loaned to it by other banks
Securities Sold Under Agreement to Repurchase (Repurchase Agreements)
McGraw-Hill/Irwin
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Equity Capital (EC)Equity Capital (EC)
Preferred StockPreferred Stock Common StockCommon Stock
Common Stock OutstandingCommon Stock Outstanding Capital SurplusCapital Surplus Retained Earnings (Undivided Profits)Retained Earnings (Undivided Profits) Treasury Stock (Retired stock)Treasury Stock (Retired stock) Contingency Reserve (Unforeseen losses)Contingency Reserve (Unforeseen losses)
McGraw-Hill/Irwin
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© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Composition of Bank Balance Statements(Percentage Mix of Bank Sources and Uses of Funds)
All Banks %
Bank < $100 Million
%
Banks Between
$100 Mill. - $1 Bill. %
Banks > $1 Billion %
Cash and Deposits Due from Banks 5.95 5.72 4.64 6.16
Investment Securities 17.96 24.00 22.65 17.02
Fed Funds Sold and Repos. 4.84 5.60 3.57 4.99
Total Loans and Leases (Net) 58.20 60.22 64.04 57.25
Commercial and Industrial 25.20 17.18 17.76 26.77
Consumer 16.19 12.44 10.95 17.21
Real Estate 46.26 58.64 66.10 42.47
To Depository Institutions 3.01 0.00 0.28 3.58
To Foreign Governments 0.19 0.00 0.12 0.23
Agriculture 1.23 10.32 2.96 0.56
Other Loans 3.56 1.03 1.12 4.05
Leases 4.36 0.39 0.71 5.13
Assets Held in Trading Accounts 4.62 0.00 0.00 5.48
Bank Premises and FA (Net) 1.17 1.88 1.81 1.04
Other Assets 7.26 2.58 3.29 8.06
Total Assets 100.00 100.00 100.00 100.00
Interest Bearing Deposits 53.55 71.69 68.77 50.57
Noninterest Bearing Deposits 13.30 13.00 12.80 13.34
Fed Funds Purchased and Repos. 7.66 0.91 2.70 8.66
Other Liabilities 16.40 3.50 6.05 18.44
Total Equity Capital 9.09 10.90 9.68 8.94
Total Liabilities and Equity 100.00 100.00 100.00 100.00
McGraw-Hill/Irwin
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Off-Balance-Sheet Items
Fee generating services not fully disclosed in Fee generating services not fully disclosed in the balance sheet:the balance sheet:
Unused Commitments: Unused Commitments: Bank received a fee to Bank received a fee to lend up to a certain amountlend up to a certain amount
Standby Credit AgreementsStandby Credit Agreements: Bank promises : Bank promises to guarantee repayment of a customer’s to guarantee repayment of a customer’s loan taken from a third partyloan taken from a third party
Derivative Contracts: Derivative Contracts: financial institution has financial institution has the possibility to incur profit or lossthe possibility to incur profit or loss
Make the bank more risky than Make the bank more risky than appeared in the financial appeared in the financial
statementsstatements
McGraw-Hill/Irwin
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Report of Income
The Statement of Revenues, Expenses and Profits for a Bank
McGraw-Hill/Irwin
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Net Interest Income = Interest Income – Interest Expenses
Interest and Fees on Loans
Taxable Securities Revenue
Tax-Exempt Securities Revenue
Other Interest Income
Deposit Interest Costs Interest on Short-Term
Debt Interest on Long-Term
Debt
Interest IncomeInterest Income Interest ExpensesInterest Expenses
McGraw-Hill/Irwin
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Net Noninterest Income = Noninterest Income – Noninterest Expenses
Service Charges on Customers Deposits
Trust Department Income
Other Operating Income
Wages and Salaries Other Personnel
Expenses Net Occupancy
Expenses Other Operating
Expenses
Noninterest IncomeNoninterest Income Noninterest ExpensesNoninterest Expenses
McGraw-Hill/Irwin
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Income Statement
Net Interest Income XXXXX
-Provision for Loan Loss XXXXX
Net Income After PLL XXXXX
+/- Net Noninterest Income XXXXX
Net Operating Income XXXXX
+/- Security Gain (loss) XXXXX
Net Income Before Taxes XXXXX
-Taxes XXXXX
Net Income XXXXX
-Dividends XXXXX
Undivided Profits XXXXX
McGraw-Hill/Irwin
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Provisions for Possible Loan Loss (PLL)
Experience Method Specific Charge-Off Method
Example: Suppose a bank anticipated loan losses this year of Example: Suppose a bank anticipated loan losses this year of $10,000 and held $100 thousand already in the ALL account.$10,000 and held $100 thousand already in the ALL account.
Beg. Bal. Allowance for Loan Losses (ALL) = $ 100,000Beg. Bal. Allowance for Loan Losses (ALL) = $ 100,000
+ This year’s Provision for Loan losses (PLL) = + This year’s Provision for Loan losses (PLL) = $ 10,000$ 10,000
Adjusted Allowance for Loan Losses (ALL) = $110,000Adjusted Allowance for Loan Losses (ALL) = $110,000
-Actual Charge-offs for worthless loans = Actual Charge-offs for worthless loans = $ 5000 $ 5000
Net Allowance for Loan Losses = $105,000Net Allowance for Loan Losses = $105,000
+Recoveries from Previously Charged-off Loans = +Recoveries from Previously Charged-off Loans = $ 3,000$ 3,000
End. Bal. in the Allow. for Loan Loss Ac.(ALL) = $108,000End. Bal. in the Allow. for Loan Loss Ac.(ALL) = $108,000
McGraw-Hill/Irwin
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Statement of Stockholders’ Equity
Report Showing the Changes in the Make Up of the Bank’s Capital Account
McGraw-Hill/Irwin
1-21
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Statement of Stockholders’ Equity
Beginning Capital Account Balance
+/- Net Income for Period- Preferred Stock Dividends- Common Stock Dividends
+ New Shares of Stock Issued- Purchases of Treasury Stock
Ending Capital Account Balance
McGraw-Hill/Irwin
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Sources and Uses of Funds Statement
Also Known as the Funds-Flows Statement It asks Two Questions Where Do Funds Come From? How Were Those Funds Utilized?
McGraw-Hill/Irwin
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Sources and Uses of Funds
Net Income Noncash Expenses Decrease in Assets Increase in
Liabilities Increase in Capital
Accounts
Net Loss Dividends Increase in Assets Decrease in
Liabilities Decrease in Capital
Accounts
SourcesSources UsesUses
McGraw-Hill/Irwin
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Financial Statements of Bangladeshi Banks
Bank Companies Act, 1991 Section 38 Format of Financial Statements
McGraw-Hill/Irwin
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The Financial Statements of Nonbank Financial The Financial Statements of Nonbank Financial FirmsFirms
The financial statements of other financial The financial statements of other financial institutions, in recent years, come closer to institutions, in recent years, come closer to bank statementsbank statements
Finance Company:Finance Company:
•USE: Loan> Receivables:USE: Loan> Receivables:
BS is dominated by loans> Called BS is dominated by loans> Called “Accounts Receivable”>Business “Accounts Receivable”>Business receivables, consumer receivables, real receivables, consumer receivables, real estate receivables> estate receivables> reflecting loans made reflecting loans made to these customersto these customers
•SOURCE: Deposit>Borrowings:SOURCE: Deposit>Borrowings:
Borrowings from the money Borrowings from the money market>Borrowings from banks etc.market>Borrowings from banks etc.
McGraw-Hill/Irwin
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Life/Property Insurance Company:Life/Property Insurance Company:
•USE:Loan> Loans to the business sectorUSE:Loan> Loans to the business sector
Holding of bonds, stocks and mortgagesHolding of bonds, stocks and mortgages
•SOURCE: Deposit>PremiumSOURCE: Deposit>Premium
Premium payment, Borrowings in the Premium payment, Borrowings in the money and capital marketsmoney and capital markets
Mutual Funds:Mutual Funds:
•USE:Loan>USE:Loan>
Corporate stocks, bonds, asset backed Corporate stocks, bonds, asset backed securitiessecurities
•SOURCE:SOURCE:
Selling of fund sharesSelling of fund shares
McGraw-Hill/Irwin
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Problem of Book Value Problem of Book Value AccountingAccounting
McGraw-Hill/Irwin
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Balance sheet figures are based on historical costs instead of Balance sheet figures are based on historical costs instead of current market values.current market values.
• This comes from the This comes from the cost principlecost principle of accounting which of accounting which
states that, values on the balance sheet should be states that, values on the balance sheet should be recorded on their original cost. recorded on their original cost.
>For example, if an equipment is purchased for $5,000, it should be >For example, if an equipment is purchased for $5,000, it should be recorded as $5,000. No matter whether the equipment is actually recorded as $5,000. No matter whether the equipment is actually worth more or less than the amount purchased. This may mislead worth more or less than the amount purchased. This may mislead the investors or creditors regarding the true value of the firms’ the investors or creditors regarding the true value of the firms’ assets and also will cause trouble in replacement of the assets.assets and also will cause trouble in replacement of the assets.
• In order to solve this problem, on October 1979 the In order to solve this problem, on October 1979 the Financial Accounting Standard Boards (FASB) issued a Financial Accounting Standard Boards (FASB) issued a ruling that required large companies to disclose inflation-ruling that required large companies to disclose inflation-adjusted accounting data in addition to their traditional adjusted accounting data in addition to their traditional historical cost data. However, with the fall in the inflation historical cost data. However, with the fall in the inflation rate this rule is no longer in force. rate this rule is no longer in force.
Discussion Case: Limitations of the Balance SheetDiscussion Case: Limitations of the Balance SheetHistorical Cost versus Current Market Value AccountingHistorical Cost versus Current Market Value Accounting
McGraw-Hill/Irwin
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Problem of Book Value Accounting in Banks/FIs
Assumes that all balance sheet items will be held to Assumes that all balance sheet items will be held to maturitymaturity
Does not show the impact of Does not show the impact of changing interest rates changing interest rates and and default risk default risk etc.etc.
Auditors do not guarantee the accuracy of earnings, Auditors do not guarantee the accuracy of earnings, but only that statements are a fair financial but only that statements are a fair financial representationrepresentation
EPS for a company is not a precise figure that is EPS for a company is not a precise figure that is readily comparable over time or between companiesreadily comparable over time or between companies
McGraw-Hill/Irwin
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Ethics in Banking
““Window Dressing” or “Creative Accounting”Window Dressing” or “Creative Accounting” Manipulation of Financial Statements to Manipulation of Financial Statements to
Look Stronger and More SuccessfulLook Stronger and More Successful
