Chapter Three

The Financial Statements of Banks and Their Principal Competitors

Key Topics

• An Overview of the Balance Sheets and Income Statements of Banks and Other Financial Firms

• The Balance Sheet or Report of Condition

• Asset Items

• Liability Items

• Recent Growth of Off-Balance-Sheet Items

• Components 部件 of the Income Statement: Revenues and Expenses

• Appendix: Sources of Information on the Financial-Services Industry

Introduction p. 57

• The services each financial firm chooses to offer and the overall size of each financial-service organization are reflected in its financial statements

• Financial statements can be viewed as a “road map”• Tells us where a financial firm has been in the past,

where it is now, and possibly where it is headed in the future

• The two main financial statements that managers, customers, and the regulatory authorities rely upon are• The Balance Sheet (Report of Condition)• The Income Statement (Report of Income)

An Overview of Balance Sheets and Income Statements p. 57-59

THE BALANCE SHEET (Report of Condition)

Assets (uses of funds)

Liabilities and Equity (sources of funds)

THE INCOME STATEMENT (Report of Income)

Revenues – Use of funds to produce and sell services

Expenses – Cost of funds

An Overview of Income Statements (cont) p. 57-59

•The Income Statement shows the revenues (cash flow) made by selling services to the public, including making loans and servicing customer deposits

• It also shows net earnings after all costs are deducted from all revenues, which will be reinvested 再投资 (zài tóuzī) in the financial firm for future growth and some of which will flow to stockholders as dividends

TABLE 3–1 Key Items on Bank Financial Statements p. 58

The Balance Sheet (Report of Condition) p. 59

•A balance sheet lists the assets, liabilities, and equity capital (owners’ funds) held by or invested in a bank or other financial firm on any given date

The Balance Sheet p. 59

• For banks the assets on the balance sheet are of 4 major types:▫Cash in the vault and deposits held at banks. (C)▫Government and private interest-bearing securities

purchased in the open market (S)▫Loans and leases made available to customers (L)▫Miscellaneous assets (MA)

• Liabilities fall into two principal categories:▫Deposits made by and owed to various customers (D)▫Nondeposit borrowings of funds in the money and capital

markets (NDB)• Equity capital represents long-term funds the owners

contribute (EC)

The Balance Sheet (Report of Condition)

•ASSETS:

•Cash assets (C) are to meet the financial firm’s need for liquidity p. 60

•Security holdings (S) are also source of liquidity and include investments that provide a source of income p. 60• Loans (L) and leases 租赁 (Zūlìn) are made to

supply income p. 62-63

•Miscellaneous 杂项 (záxiàng) assets (MA) are fixed assets (plant and equipment) and investments in subsidiaries (if any)

The Balance Sheet (Report of Condition) p. 59

•LIABILITIES:

•Deposits (D) are the main source of funding for banks p.66

▫Nondeposit borrowings (NDB) are to add to deposits and provide the additional liquidity that cash assets and securities cannot provide p.67

• Equity capital (EC) supplies the long-term, stable base of financial support which the financial firm will need to grow and to cover any extraordinary 非凡 (fēifán) losses it incurs. Comes from shareholders 股东 (gǔdōng) p. 67-68

The Balance Sheet (Report of Condition) p. 59

• One way to view the balance sheet is to note that liabilities and equity capital represent accumulated 积累 (Jīlěi) sources of funds, which provide needed spending power to acquire, to buy assets

•A bank’s assets are its accumulated 积累 Jīlěi uses of funds, which are made to generate income for its stockholders, pay interest to its depositors, and pay its employees for their labor and skill

•Thus, the balance sheet identity can be pictured simply as:

TABLE 3–2 Highlighted Bank Financial Data ($ million) from the FDIC (December 31, 2009) p. 60

TABLE 3–3 Report of Condition (Balance Sheet) for BB&T (Year-End 2008 and 2009) p. 61

The Balance Sheet (Report of Condition) (continued) p. 60•Cash Assets▫Account is called Cash and Deposits Due from

Bank▫Includes:▫Vault Cash▫Deposits with Other Banks (Correspondent

Deposits)▫Cash Items in Process of Collection▫Reserve Account with the Federal Reserve▫Sometimes called primary reserves

The Balance Sheet (cont) p. 60 • Investment Securities - The Liquid Portion•Short Term Government Securities•Privately Issued Money Market Securities▫Interest Bearing Time Deposits▫Commercial Paper

•Often called secondary reserves

The Balance Sheet (cont) p.61

•Investment Securities - The Income-Generating Portion▫Taxable Securities▫U.S. Government Notes▫Government Agency Securities▫Corporate Bonds▫Tax-Exempt Securities▫Municipal Bonds

The Balance Sheet p. 62

• Federal Funds Sold and Reverse Repurchase Agreements• Includes mainly temporary loans (usually

extended overnight, with the funds returned the next day) made to other depository institutions, securities dealers, or major industrial corporations• The funds for these temporary loans often

come from the reserves a bank has on deposit with the Federal Reserve Bank in its district. These are “Fed Funds”

The Balance Sheet (cont) p.62-65

•Loan Accounts▫The Major Asset▫Gross Loans – Sum of All Loans▫Allowance for Possible Loan Loss▫Net Loans▫Unearned Income▫Nonperforming (bad) Loans

The Balance Sheet (cont) p. 62-65

•Types of Loans▫Commercial and industrial (or

business) loans▫Consumer (or household) loans▫Real estate (or property-based) loans▫Financial institutions loans ▫Foreign (or international) loans▫Agricultural production loans▫Security loans• Leases 租赁 (zūlìn)

The Balance Sheet (continued)

• Loan Losses

Beginning Allowance for Loan Losses

+ This Year’s Provision for Loan Loss

= Adjusted Allowance for Loan Losses

- Actual Charge-Offs 冲销 (chōngxiāo) of bad Loans + Recoveries 复原 (fùyuán) from Previous Charge-Offs

= Ending Allowance for Loan Losses

The Balance Sheet (cont) p.64

•Specific and General Reserves▫Specific Reserves▫Set aside to cover a particular Loan▫Designate a portion of ALL or▫Add more reserves to ALL

▫General Reserves▫Remaining ALL

▫Determined by management but influenced by taxes and government regulation

▫Loans to lesser developed countries require allocated transfer reserves

The Balance Sheet (continued) p.66

•Miscellaneous Assets•Bank Premises and Fixed Assets•Other Real Estate Owned (OREO)•Goodwill and Other Intangibles (extra)

The Balance Sheet (Report of Condition) (continued) p. 66-67

• Liabilities of the Banking Firm•Deposits▫Non interest-Bearing Demand Deposits▫Savings Deposits▫Now Accounts▫Money Market Deposit Accounts

(MMDA)▫Time Deposits

The Balance Sheet (Report of Condition) (continued) p. 67• Liabilities of the Banking Firm• Nondeposit Borrowings

▫Fed Funds Purchased▫Securities Sold Under Agreement to Repurchase

(Repurchase Agreements are borrowed funds from another bank)

▫Eurocurrency Borrowings from banks that are in many countries.

▫Subordinated Debt like Preferred Stock▫Other Liabilities

The Balance Sheet (Report of Condition) (continued) p. 67-68

• Equity Capital of the Banking Firm• Preferred Stock• Common Stock• Common Stock Outstanding• Capital Surplus• Retained Earnings (Undivided Profits)• Treasury Stock• Contingency 偶然性 (ouránxìng) Reserve

as a protection against losses

The Balance Sheet (Report of Condition) (continued) p. 68-70

• Recent Growth and Expansion of Off-Balance-Sheet (OBS) Items in Banking• Unused Loan Commitments• Standby Credit Agreements• Derivative Contracts

▫Futures Contracts▫Options▫Swaps

• OBS transactions expose a firm to counterparty risks• OBS items have grown so rapidly that, for the banking

industry as a whole, they exceed total bank assets many times over

TABLE 3–5 Examples of Off-Balance-Sheet Items Reported by FDIC-Insured Banks p. 69

Components of the Income Statement (Report of Income) p. 72-73

• Indicates the amount of revenue received and expenses incurred 招致 (zhāozhì) over a period of time

•Shows how much it has cost to get funds and to generate revenues from the uses of funds in the Balance Sheet

•Shows the revenues (cash flow) generated by selling services to the public

•Shows net earnings after all costs are deducted from the sum of all revenues

Components of the Income Statement (Report of Income) (continued) p. 73

Components of the Income Statement (Report of Income) (continued) p. 74-75• Income statements are a record of financial flows over

time

• Therefore, we can represent the income statement as a report of financial outflows (expenses) and financial inflows (revenues)

• Four main sections1. Interest income2. Interest expenses3. Noninterest income4. Noninterest expenses

TABLE 3–6 Report of Income (Income Statement) for BB&T (2008 and 2009) p. 74

Components of the Income Statement (Report of Income) (continued) p. 74

• Net Interest Income = Interest Income – Interest Expenses

• Interest Income Sources• Interest and Fees on Loans• Taxable Securities Revenue• Tax-Exempt Securities Revenue• Other Interest Income

• Interest Expense Sources• Deposit Interest Costs• Interest on Short-Term Debt• Interest on Long-Term Debt

Components of the Income Statement (Report of Income) (continued) p. 75

• Net Noninterest Income (mainly fee income) = Noninterest Income – Noninterest Expenses

• Noninterest Income Sources• Fees Earned from Trust Activities (managing

customers money)• Service Charges on Deposit Accounts• Trading Account Gains and Fees• Additional Noninterest Income

• Noninterest Expense Sources• Wages, Salaries, and Employee Benefits• Premises and Equipment Expense• Other Operating Expenses

CHAPTER SUMMARY

• This chapter presents an overview 概观 (gàiguān) of bank financial statements, which gives us important information managers and investors use to assess performance.• The 2 most important statements are the Balance

Sheet or Report of Condition and the Income Statement, Report of Income. • Balance sheet reports value of assets, liabilities and

stockholders’equity. These include cash, investments and loans.

CHAPTER SUMMARY (continued)

•The Income Statement includes sources of income and operating expenses. •Revenue includes loan and investment

income and fees. •Operating expenses include interest

payments on borrowed funds, employee wages, salaries and benefits, taxes.

PROBLEMS AND PROJECTS to be done in class and homework p. 82-85

• Each group will do the project for their group number. For example, group 1 complete problem 1 on page 82 and group 2, problem 2 on page 82 and so on. • Once you complete a problem do the next one. For

example group 1 will also do group 2 and so on.