FINANCIAL STATEMENTS

OF BANKS

Chapter 4

William Chittenden edited and updated the PowerPoint slides for this edition.
 Key topics

1. 1. Overview of the Balance sheets and Income

statements of banks
2. 2. Balance sheet or Report of condition
1. Asset items
2. Liability items
3. 3. Recent expansion of off-balance sheet items
4. 4. Components of the Income statement:
Revenues and Expenses
5. 5. Financial statement manipulation 2
Bank financial statements

 Report of condition – Balance sheet

 Report of income – Income statement

3
 5-4

4
Report of condition - Balance sheet

 The Balance sheet of a bank showing its

Assets, Liabilities and Net worth at a given
point in time

Assets = Liabilities + Equity

 May be viewed as a list of financial inputs

(sources of funds) and outputs (uses of funds)

5
 5-6

Balance sheet

C + S + L + MA = D + NDB + EC
C = Cash assets D = Deposits
S = Security holdings NDB = Non-deposit
L = Loans
borrowings
MA = Miscellaneous
EC = Equity capital
assets

6
 Bank assets
 Cash and due from banks
 Vault cash, deposits held at the Fed and other financial
institutions, and cash items in the process of collection
 Investment securities
 Securities held to earn interest and help meet liquidity
needs
 Loans
 The major asset, generate the greatest amount of
income, exhibit the highest default risk and are relatively
illiquid
 Other assets
 Bank premises and equipment, interest receivable,
prepaid expenses, other real estate owned, and
customers' liability to the bank
7
Balance Sheet (assets): PNC and Community National Bank
PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK
Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of
BALANCE SHEET % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total
ASSETS
Loans:
Real estate loans 1.2% 15,639,089 25.2% 32.4% 20,701,904 28.0% 4.0% 75,324 39.1% 12.9% 85,050 40.5%
Commercial loans -8.4% 11,879,285 19.2% 23.8% 14,707,458 19.9% -5.8% 34,288 17.8% 12.9% 38,716 18.4%
Individual loans -4.4% 2,501,847 4.0% 52.6% 3,816,861 5.2% 26.7% 8,454 4.4% -5.2% 8,011 3.8%
Agricultural loans 9.2% 984 0.0% 57.0% 1,545 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Other LN&LS in domestic off. -20.5% 3,022,795 4.9% -0.8% 2,999,113 4.1% 13.0% 26 0.0% 284.6% 100 0.0%
LN&LS in foreign off. 15.6% 1,190,025 1.9% 2.8% 1,222,904 1.7% 0.0% 0 0.0% 0.0% 0 0.0%
Gross Loans & Leases -4.6% 34,234,025 55.2% 26.9% 43,449,785 58.9% 2.2% 118,092 61.3% 11.7% 131,877 62.8%
Less: Unearned Income 8.0% 44,867 0.1% 0.2% 44,949 0.1% 0.0% 0 0.0% 0.0% 0 0.0%
Memo: Total loans -4.6% 34,189,158 55.1% 27.0% 43,404,836 58.8% 2.2% 118,092 61.3% 11.7% 131,877 62.8%
Loan & Lease loss Allowance -5.8% 606,886 1.0% -3.8% 583,915 0.8% 6.7% 1,258 0.7% 28.5% 1,617 0.8%
Net Loans & Leases -4.5% 33,582,272 54.1% 27.5% 42,820,921 58.0% 2.2% 116,834 60.6% 11.5% 130,260 62.0%
Investments:
U.S. Treasury & Agency securities 90.6% 5,574,108 9.0% 15.9% 6,460,936 8.8% 73.9% 34,937 18.1% 24.8% 43,591 20.7%
Municipal securities -46.9% 7,719 0.0% 1606.0% 131,685 0.2% -0.5% 613 0.3% -0.5% 610 0.3%
Foreign debt securities -100.0% 0 0.0% 0% 0 0.0% 0.0% 0 0.0% 0% 0 0.0%
All other securities 1.1% 8,804,028 14.2% 3.0% 9,064,146 12.3% #N/A 2,104 1.1% -2.2% 2,057 1.0%
Interest bearing bank balances 16.4% 259,318 0.4% 51.8% 393,713 0.5% #N/A 4,428 2.3% -57.5% 1,881 0.9%
Fed funds sold & resales -54.6% 1,106,733 1.8% 56.2% 1,728,372 2.3% 175.0% 7,000 3.6% -21.4% 5,500 2.6%
Trading account assets -9.1% 935,042 1.5% 78.3% 1,667,330 2.3% 0.0% 0 0.0% 0.0% 0 0.0%
Total Investments 8.7% 16,686,948 26.9% 16.5% 19,446,182 26.3% 111.1% 49,082 25.5% 9.3% 53,639 25.5%
Total Earning Assets -0.5% 50,269,220 81.1% 23.9% 62,267,103 84.4% 20.6% 165,916 86.1% 10.8% 183,899 87.5%
Nonint Cash & Due from banks -6.9% 2,926,330 4.7% 8.5% 3,174,493 4.3% -16.6% 13,083 6.8% -10.7% 11,682 5.6%
Premises, fixed assets & capital leases
24.4% 1,039,603 1.7% 2.5% 1,066,028 1.4% 12.2% 5,642 2.9% 2.2% 5,768 2.7%
Other real estate owned 21.8% 14,208 0.0% 0.7% 14,301 0.0% -84.3% 325 0.2% -100.0% 0 0.0%
Investment in unconsolidated subs. 252.4% 17,386 0.0% -12.4% 15,223 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Acceptances and other assets 51.8% 7,754,149 12.5% -6.2% 7,272,017 9.9% 259.8% 7,761 4.0% 13.2% 8,783 4.2%
Total Assets 4.0% 62,020,896 100.0% 19.0% 73,809,165 100.0% 18.6% 192,727 100.0% 9.0% 210,132 100.0%
Average Assets During Quarter 6.8% 62,719,462 101.1% 17.0% 73,391,052 99.4% 17.5% 191,480 99.4% 9.4% 209,525
8 99.7%
 5-9

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)

9
Characters of cash assets
 The highest liquid asset => 1st line of
defense against liquidity needs
(withdrawals of depositors including
principal and interests, demand for loans,
payments to creditors, other financial
obligations) => the primary reserve
 The lowest profitable item => keep as low
as possible

10
 5-11

Investment Securities: the liquid portion

 Often called secondary reserves ~ 2nd line of

defense against liquidity needs, include:
TRADABLE SECURITIES
 Short term government securities
 Privately issued money market securities
 Interest bearing time deposits
 Commercial paper
11
12
 5-13

Investment securities
 These are the income generating portion of securities
=> gain interest revenues, long-term bonds or notes
with high expected interest rate ~ held-to-maturity IS
 Taxable securities: interests are subject to income tax
 U.S. Government notes
 Government agency securities
 Corporate bonds
 Tax-exempt securities: interests are exempt from
income tax
13

 Municipal bonds
How to record the value of IS on the
BS
 Method of accounting to record IS:
+ at market value: value is determined in
the market, based on the force of demand
& supply
+ at book value/historical value/original
value: based on historical costs
 The value IS is recorded at book value or
market value based on which is lower.

14
 5-15

Trading account assets

 Securities purchased to provide short-term

profits from short-term price movements

 When bank acts as a securities dealer

 Valued at market – FASB 115

15
 Federal funds sold and reverse 5-16

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
Fed funds solds: Hợp đồng vay liên ngân hàng
16
Reverse repurchase agreements: Hợp đồng mua lại đảo ngược
 Bank investments and FASB 115
 Following FASB 115, a bank, at purchase, must
designate the objective behind buying investment
securities as either:
 Held-to-maturity securities are recorded on the balance
sheet at amortized cost.
 Trading account securities are actively bought and sold,
so the bank marks the securities to market (reports them
at current market value) on the balance sheet and reports
all gains and losses on the income statement.
 Available-for-sale, all other investment securities, are
recorded at market value on the balance sheet with a
corresponding change to stockholders’ equity as
unrealized gains and losses on securities holdings; no
income statement impact.
17

Amortized cost: Giá gốc sau khi đã phân bổ

 5-18

Loan accounts

 The major asset

 Gross loans – sum of all loans
 Allowance for possible loan losses
 Contra asset account
 For potential future loan losses
 Net loans
 Unearned discount income
 Nonperforming loans
18
 5-19

Types of loans – based on purpose of

borrowing money
 Commercial and industrial loans ~ business loans
 Consumer loans (loans to individuals)
 Real estate loans
 Financial institution loans
 Foreign loans
 Agriculture production loans
 Security loans
 Leases~ financial lease (not operating lease)
19
Adjustments to total loans
…three adjustments are made to obtain a net loan
figure.

1. Leases are included in gross loans.

2. Unearned income is deducted from gross
interest received.
3. Gross loans are reduced by the dollar
magnitude of a bank's loan-loss reserve,
which exists in recognition that some loans
will not be repaid.
20
 5-21

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
ALL : Allowance for loan losses 21
 5-22

Allowance for loan losses (ALL)

Beginning ALL
+ Provision for loan loss (Income statement)
= Adjusted allowance for loan losses
- Actual charge-offs

+ Recoveries from previous charge-offs

= Ending allowance for loan losses
VN: see Circular 11/2021/TT-NHNN

22
 5-23

Circular 02/2013/TT-NHNN
Loan classification:
Group 1: Standard loans (Nợ đủ tiêu chuẩn)
Group 2: Special mentioned loans (Nợ cần chú ý)
Group 3: Sub-standard loans (Nợ dưới tiêu chuẩn)
Group 4: Doubtful loans (Nợ nghi ngờ)
Group 5: Potentially inrecoverable loans (Nợ có khả
năng mất vốn)
Formula:
Specific reserve: (A – C ) x R
General reserve: sum (Groups 1-4) x 0.75%
23
 5-24

Circular 02/2013/TT-NHNN
Specific reserve:
(A – C ) x R
A: outstanding loan value R: reserve ratio
C: revaluated collateral value
Group 1: R = 0%
Group 2: R = 5%
Group 3: R = 20%
Group 4: R = 50%
Group 5: R = 100%
24
 Provisions for loan losses

Recoveries

Provisions for loan losses

Reserve for Loan Losses Charge offs

25
 Average assets, capital and loan loss data: PNC and Community NB
PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK
Enter analysts name here Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of
SUPPLEMENTAL DATA Pg # % Cha $ 1,000 Total % Cha $ 1,000 Total % Cha $ 1,000 Total % Cha $ 1,000 Total
Average Assets 1 2.36% 60,890,137 14.30% 69,596,163 11.59% 176,531 13.45% 200,271
Domestic Banking offices 3 0.59% 684 7.75% 737 0.00% 5 20.00% 6
Foreign Branches 3 0.00% 8 0.00% 8 0.00% 0 0.00% 0
Number of equivalent employees 3 -1.72% 15,147 3.49% 15,675 -3.02% 64 9.85% 71

SUMMARY OF RISK BASED CAPITAL

Net Tier One 11A -0.49% 5,134,748 9.9% -0.90% 5,088,306 8.4% 14.19% 14,005 10.7% 9.09% 15,278 10.3%
Net Eligible Tier Two 11A -9.20% 1,566,924 3.0% 28.12% 2,007,618 3.3% 6.70% 1,258 1.0% 28.54% 1,617 1.1%
Tier Three 11A 36.19% (12,269) 0.0% 408.06% (62,334) -0.1% 0.00% 0 0.0% 0.00% 0 0.0%
Deductions 11A -2.73% 6,689,403 12.9% 5.15% 7,033,591 11.5% 13.53% 15,263 11.7% 10.69% 16,895 11.4%
Total-risk-based-capital 11A -2.73% 13,378,806 25.8% 5.15% 14,067,181 23.1% 13.53% 30,526 23.4% 10.69% 33,790 22.7%
Total Risk-Weighted Assets 11A -1.95% 51,908,044 100.0% 17.32% 60,897,630 100.0% 12.72% 130,506 100.0% 14.03% 148,814 100.0%

SUMMARY OF LOAN LOSS ACCOUNT

Balance at beginning of period 7 6.92% 644,475 1.8% -5.83% 606,886 1.5% 38.87% 1,179 1.0% 6.70% 1,258 1.0%
Gross Credit Losses 7 2.40% 255,377 0.7% -36.75% 161,537 0.4% 277.91% 616 0.5% -57.79% 260 0.2%
Memo: Loans HFS Writedown 7 14.01% 26,060 0.1% -67.16% 8,558 0.0% 0.00% 0 0.0% 0.00% 0 0.0%
Recoveries 7 11.29% 47,453 0.1% 5.05% 49,849 0.1% -15.38% 11 0.0% 72.73% 19 0.0%
Net Credit Losses 7 0.56% 207,924 0.6% -46.28% 111,688 0.3% 303.33% 605 0.5% -60.17% 241 0.2%
Provisions for Credit Losses 7 -39.11% 176,612 0.5% -70.81% 51,553 0.1% 42.50% 684 0.6% -12.28% 600 0.5%
Other Adjustments 7 -84.91% (6,277) 0.0% -692.07% 37,164 0.1% 0.00% 0 0.0% 0.00% 0 0.0%
Balance at end of period 7 -5.83% 606,886 1.7% -3.79% 583,915 1.5% 6.70% 1,258 1.1% 28.54% 1,617 1.3%
Average Total Loans & Leases 7 -8.74% 35,193,158 100.0% 13.55% 39,960,849 100.0% 5.43% 114,953 100.0% 7.38% 123,431 100.0%

NON-CURRENT LN&LS
90 days and over past due 8 -53.71% 72,963 0.2% -20.54% 57,979 0.1% -38.05% 184 0.2% -100.00% 0 0.0%
Total Nonaccrual Ln&LS 8 -21.98% 270,782 0.8% -47.60% 141,887 0.4% -42.61% 229 0.2% -9.17% 208 0.2%
Total Non-current LN&LS 8 -31.89% 343,745 1.0% -41.86% 199,866 0.5% -40.66% 413 0.4% -49.64% 208 0.2%
Ln&Ls 30-89 Days Past Due 8 -49.74% 126,455 0.4% -25.05% 94,779 0.2% -68.98% 844 0.7% 167.89% 2,261 1.8%
Restructured LN&LS 90+ Days P/D 8 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Restructured LN&LS Nonaccrual 8 -65.1% 424 0.0% -100.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Current Restructured LN&LS 8 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
All other real estate owned 8 21.8% 14,208 0.0% 0.7% 14,301 0.0% -84.3% 325 0.3% -100.0% 0 0.0%
26
 5-27

Miscellaneous assets

 Bank premises and fixed assets

 Other real estate owned (OREO)

 Goodwill and other intangibles

27
Bank liabilities
 Non interest-bearing demand deposits
 Transactions accounts that pay no interest
 Negotiable orders of withdrawal (NOWs) and
automatic transfers from savings (ATS) accounts
 Pay interest set by each bank without federal
restrictions
 Money market deposit accounts (MMDAs)
 Pay market rates, but a customer is limited to no
more than six checks or automatic transfers each
month
 Savings and time deposits represent the bulk of
interest-bearing liabilities at banks.
28
Bank liabilities (cont.)
 Two general time deposits categories exist:
 Time deposits in excess of $100,000, labeled
jumbo certificates of deposit (CDs).
 Small CDs, considered core deposits which tend
to be stable deposits that are typically not
withdrawn over short periods of time.
 Deposits held in foreign offices
 Balances issued by a bank subsidiary located
outside the U.S.

29
 5-30

Non-deposit borrowings

 Fed funds purchased

 Securities sold under agreement to
repurchase (repurchase agreements)
 Acceptances outstanding
 Eurocurrency borrowings
 Subordinated debt (Notes and bonds with
maturities in excess of one year)
 Limited life preferred stock
 Other liabilities 30
Core versus volatile funds
 Core deposits are stable deposits that are not highly
interest rate-sensitive.
 More sensitive to the fees charged, services rendered, and
location of the bank.
 Includes: demand deposits, NOW accounts, MMDAs, and
small time deposits.
 Large, or volatile, borrowings are liabilities that are highly
rate-sensitive.
 Normally issued in uninsured denominations
 Ability to borrow is asset quality sensitive
 Includes: large CDs (over $100,000), deposits in foreign
offices, federal funds purchased, repurchase agreements,
and other borrowings with maturities less than one year.*
*The UBPR (Uniform Bank Performance Report ) also includes brokered
deposits less than $100,000 and maturing within one year in the definition of
net non-core liabilities. 31
 Balance Sheet (liabilities): PNC and Community National Bank
PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK
Dec-03 % of Dec-04 % of Dec-03 % of Dec-04 % of
BALANCE SHEET % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total % Cha 1,000 Total

LIABILITIES
Demand deposits 2.6% 7,070,434 11.4% 20.1% 8,488,607 11.5% 12.6% 72,500 37.6% 12.4% 81,514 38.8%
All NOW & ATS Accounts 9.9% 1,529,861 2.5% 8.9% 1,666,003 2.3% 15.5% 12,478 6.5% 39.7% 17,437 8.3%
Money market deposit accounts 6.8% 24,502,371 39.5% 8.8% 26,665,024 36.1% 56.7% 46,458 24.1% 5.3% 48,908 23.3%
Other savings deposits 5.0% 2,055,659 3.3% 35.4% 2,782,931 3.8% 7.3% 7,812 4.1% 26.7% 9,896 4.7%
Time deposits under $100M -15.9% 6,242,628 10.1% 13.1% 7,063,499 9.6% 4.0% 24,469 12.7% -14.4% 20,949 10.0%
Core Deposits 2.0% 41,400,953 66.8% 12.7% 46,666,064 63.2% 20.7% 163,717 84.9% 9.2% 178,704 85.0%
Time deposits of $100M or more -17.6% 1,775,943 2.9% 80.5% 3,205,331 4.3% 4.9% 13,572 7.0% 8.4% 14,714 7.0%
Deposits held in foreign offices 71.5% 2,371,548 3.8% 26.3% 2,994,623 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Total deposits 3.2% 45,548,444 73.4% 16.1% 52,866,018 71.6% 19.3% 177,289 92.0% 9.1% 193,418 92.0%
Fed funds purchased & resale 25.2% 499,232 0.8% 221.8% 1,606,647 2.2% 0.0% 1,000 0.5% 0.0% 1,000 0.5%
FHLB borrowings < 1 Yr 898.2% 1,000,000 1.6% -100.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Other borrowings inc mat < 1 yr 99.4% 2,264,921 3.7% 34.5% 3,046,632 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Memo: S.T. non core funding 73.5% 7,111,124 11.5% 25.7% 8,936,809 12.1% 0.1% 7,901 4.1% 28.7% 10,169 4.8%
Memo: S.T. Volatile liabilities 36.2% 6,911,644 11.1% 57.0% 10,853,233 14.7% 4.5% 14,572 7.6% 7.8% 15,714 7.5%
FHLB borrowings > 1 Yr -90.0% 115,406 0.2% -23.3% 88,508 0.1% 0.0% 0 0.0% 0.0% 0 0.0%
Other borrowings inc mat > 1 yr -2.9% 1,765,851 2.8% 105.2% 3,624,223 4.9% 0.0% 0 0.0% 0.0% 0 0.0%
Acceptances & other liabilities -0.1% 3,864,388 6.2% 18.7% 4,585,994 6.2% -11.0% 395 0.2% 31.6% 520 0.2%
Total Liabilities before Sub. Notes 4.6% 55,058,242 88.8% 19.5% 65,818,022 89.2% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
Sub. Notes & Debentures 16.2% 1,340,133 2.2% 41.4% 1,895,482 2.6% 0.0% 0 0.0% 0.0% 0 0.0%
Total Liabilities 4.9% 56,398,375 90.9% 20.1% 67,713,504 91.7% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
All common and preferred capital -4.1% 5,622,521 9.1% 8.4% 6,095,661 8.3% 12.0% 14,043 7.3% 8.2% 15,194 7.2%
Total Liabilities & Capital 4.0% 62,020,896 100.0% 19.0% 73,809,165 100.0% 18.6% 192,727 100.0% 9.0% 210,132 100.0%
Memoranda:
Officer, Shareholder Loans (#) 0.0% 2 0.0% 50.0% 3 0.0% -50.0% 1 0.0% 0.0% 1 0.0%
Officer, Shareholder Loans ($) -19.4% 14,211 0.0% 58.0% 22,449 0.0% 31.7% 1,852 1.0% 22.2% 2,263 1.1%
Non-investment ORE 21.8% 14,208 0.0% 0.7% 14,301 0.0% -84.3% 325 0.2% -100.0% 0 0.0%
Loans Held for Sale -10.2% 1,378,603 2.2% 20.9% 1,667,154 2.3% 0.0% 0 0.0% 0.0% 0 0.0%
Held-to Maturity Securities #N/A 2,114 0.0% -100.0% 0 0.0% 36.7% 4,073 2.1% -56.2% 1,785 0.8%
Available-for-Sale-Securities 23.4% 14,383,741 23.2% 8.9% 15,656,767 21.2% 89.4% 33,581 17.4% 32.4% 44,473 21.2%
Total Securities 23.4% 14,385,855 23.2% 8.8% 15,656,767 21.2% 81.8% 37,654 19.5% 22.9% 46,258 22.0%
32
All Brokered Deposits 14.2% 1,533,123 2.5% 49.3% 2,289,151 3.1% 0.0% 0 0.0% 0.0% 0 0.0%
Stockholders equity
 Stockholders' equity
 Ownership interest in the bank
 Common and preferred stock are listed at par
 Surplus account (= purchase value - par value of
issued stocks)
 Retained earnings (accumulated net income not
paid out as cash dividends)
 Treasury stock (retired stock)
 Contingency reserve (protection against
unforeseen losses)

33
 5-34

Comparative
Balance
Sheet
Ratios for
Different Size
Banks (FDIC,
2006)

- What are the differences among banks according to their size? 34

Off-balance-sheet items
 What are on-balance-sheet items?
 What are off-balance-sheet items?
 Why do banking firms record off-balance-
sheet items?
 What do banking firms receive from off-
balance-sheet items?

35
 Off balance sheet items indicates
items that have not yet generated by
liabilities and equity capital.
 Follow to the risk exposure relating
items

36
 5-37

Off-balance-sheet items
 Unused commitments: committed amount to lend over
a defined period of time
 Standby credit agreements: guarantee repayment of a
loan that borrower received from another lender
 Derivative contracts: potential to earn profit or incur loss
on an asset that the bank presently does not own
 Futures contracts
 Options
 Swaps
 Off-balance-sheet transactions exposure a firm to
counterparty risks
37
 5-38

Off-balance-sheet items
 Often expose the bank to considerable risk that
conventional financial statements do not
capture
 Unauthorized trading in derivatives caused
notorious losses for financial institutions
around the world
E.g. see the collapse of 234-year-old Barings
Bank in 1995 by Nicholas Leeson
http://www.time.com/time/2007/crimes/18.html
38
Food for thought
For each of the  Dudu has just opened a time
transactions deposit in the amount of $6,000
and these funds are immediately
described here,
loaned to Susu to purchase a
which of at least used car.
two accounts on a
bank’s balance
Gross Loans Total Deposits
sheet would be
+$6,000 +$6,000
affected by each
transaction?

39
Food for thought
 The bank sells a new
issue of common
stock for $100,000 to
Bank
investors living in its Premises &
community, and the Equipment, Common
proceeds of that sale Gross + Stock +
are spent on the $100,000 $100,000
installation of new
ATMs

40
Food for thought
 Ms. Juju withdraws her
checking account balance
of $2,500 from the bank
and moves her deposit to a
credit union; the bank Total
employs the funds received Gross Loans Deposits
from Mr. Bubu, who just -$2,500 -$2,500
paid off his home equity
loan, to provide Ms. Juju
with the funds she
withdrew.

41
Food for thought
 SING Bank makes a loan
of reserves in the amount
of $5 million to the State
Bank and the funds are
returned the next day. On
the day the funds are
loaned the accounts are
affected in the following
manner: Cash and Due from Bank -
$5,000,000
Federal Funds Sold +
$5,000,000
42
 5-43

Report of income
 The statement of revenues, expenses and
profits for a bank over a period of time
 Shows how much it has cost to acquire funds
and to generate revenues from the uses of
funds in Report of conditions
 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
43
 5-44

Report of Income for BB&T Corporation – (p 147)

44
Questions

1. What are total incomes/total expenses?

2. What are the proportion of each income item

in 2 years? Comment.

3. What are the proportion of each expense item

in 2 years? Comment.

45
 5-46

Net interest income =

Interest income – Interest expenses
Interest income Interest expenses
 Interest and fees on  Deposit interest costs
loans and leases  Interest on short-term
 Interest on deposits held debt
at other institutions  Interest on long-term
 Taxable securities debt
revenue
 Tax-exempt securities
revenue
 Other interest income
46
 5-47
Net noninterest income =
Noninterest income – Noninterest expenses

Noninterest income Noninterest expenses

 Fees earned from  Wages, salaries, and

fiduciary activities employee benefits
 Service charges on  Premises and
deposit accounts equipment expense
 Trading account gains  Other operating
and fees
expenses
 Additional noninterest
income

47
 5-48

Fees earned from fiduciary activities

 Fees for managing protecting a customer’s

property
 Fees for record keeping for corporate security
transactions and dispensing interest and
dividend payments
 Fees for managing corporate and individual
pension and retirement plans

48
 5-49

Service charges on deposit accounts

 Checking account maintenance fees

 Checking account overdraft fees
 Fees for writing excessive checks
 Savings account overdraft fees
 Fess for stopping payment of checks

49
 5-50

Trading account gains and fees

Net gains and losses from trading cash

instruments and off balance sheet derivative
contracts that have been recognized during the
accounting period.

50
 5-51

Additional noninterest income

 Investment banking, advisory, brokerage and
underwriting
 Venture capital revenue
 Net servicing fees
 Net securitization income
 Insurance commission fees and income
 Net gains (losses) on sales of loans
 Net gains (losses) on sales of real estate
 Net gains (losses) on the sales of other assets
51
Noninterest expense
…composed primarily of:
 Personnel expense:
 Salaries
and fringe benefits paid to bank
employees
 Occupancy expense :
 Rentand depreciation on equipment and
premises, and
 Other operating expenses:
 Utilities
 Deposit insurance premiums
 …. 52
Noninterest expense

 Expenses and loan losses directly affect the

balance sheet.
 The greater the size of loan portfolio, the
greater is operating overhead and provision
loan loss
 Consumer loans are usually smaller and hence
more costly (non-interest) per dollar of loans.
53
 5-54

Income statement
Net interest income
- Provision for loan loss
Net income after PLL
+/- Net noninterest income
Net income before taxes
Taxes
Net income
- Dividends
Undivided profits

54
You know the following information about the
CANDY Bank

what is the value of this bank's pretax net operating income

(or net income before extraordinary items)?
Solution: $150
what is the value of this bank's net income?
55
Solution: $120
 5-56
Comparative Income Statement Ratios for Different Size Banks
(FDIC, 2006)

What are the most important revenue and expense items on the income statement
56
of a bank?
Quick check

1. Questions 5.10 and 5.11 – page 149.

2. What are the relationships among items in

Report of Conditions and Report of Income?

3. Drawing the BS and IS in your notebook

4. Making the lines among related items

57
 5-58

58
Key items on bank FSs
 Snapshot: What are the similar and
different items of banks compare to non-
financial firms?
- Balance sheet
- Income statement

 What do these differences mean?

59
Financial statement manipulation
 The problem with book-value accounting
 Original (historical, book-value) cost
 Amortized cost
 Market-value
 Held-to-maturity and available-for-sale securities
 Off-balance sheet activities
 Enron and “Special-purpose vehicles”
(http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articl
es/specpurpentity.htm)
 Window dressing
 Eliminate Fed borrowing prior to financial statement
reporting date 60

 Increase asset size prior to year-end

Food for thoughts
 Ethics in banking and financial services:
The cosmetics of “window dressing” and
“creative accounting” – p. 151.
 Do you think it will apply to Vietnamese
banks?
 How to deal with this problem?

61
Financial statement manipulation (cont.)

 Non-performing loans
 Banks may lend borrower funds to make payments on
past due loans, understating non-performance status
 Allowance for loan losses
 Management discretion and IRS* regulations may be in
conflict
 Preferred stock
 Meets capital requirements but causes NIM (net
interest margin), NI (net interest), ROE, and ROA to be
overstated
*IRS (Internal Revenue Service): the US federal government agency
that collects taxes and enforces the internal revenue laws.
62
Financial statement manipulation (cont.)

 Securities gains and losses

 Banks often classify all investment securities
as “available for sale,” overstating any true
“gains or losses”
 Non-recurring sales of assets
 Thistype of transaction is not part of the
bank’s daily activities and typically cannot be
repeated; thus it overstates earnings

63
Questions & Problems
1. What are the essential differences among demand deposits,
savings deposits, and time deposits?
2. What are primary reserves, and secondary reserves and what
are they supposed to do?
3. How do the financial statements of major nonbank financial
firms resemble or differ from bank financial statements?
Why do these differences or similarities exist?
4. What major trends are changing the content of the financial
statements prepared by financial firms?
5. Problem 5 and 6 (page 157) and 11 (page 159)
NB. Problem 11: Pretax net operating income = $252 64
Answers
1. What are the essential differences among demand deposits,
savings deposits, and time deposits?
- Demand deposits are regular checking accounts against
which a customer can write checks or make any number
of personal withdrawals. Regular checking accounts do
not bear interest under current U.S. law and regulation.
- Savings deposits bear interest (normally, they carry the
lowest rate paid on bank deposits) but may be withdrawn
at will (though a bank usually will reserve the right to
require advance notice of a planned withdrawal).

65
Answers
1. What are the essential differences among demand deposits,
savings deposits, and time deposits?
 Time deposits carry a fixed maturity & the bank may
impose a penalty if the customer withdraws funds before
the maturity date. Interest rate is negotiated between the
bank and depositor, may be either fixed or floating.
 A NOW account combines features of a savings account
and a checking account:
 a money market deposit account encompasses
transactional powers (with limitations on the number of
checks or drafts that may be written against the account)
 interest rate fixed for a brief period (such as weekly) but
then becomes changeable over longer periods to reflect
current market conditions. 66
Answers
2. What are primary reserves, and secondary reserves and what are
they supposed to do?
 Primary reserves include a bank's vault cash and checkable
deposits held with other banks or any other funds that are
accessible immediately to meet demands for liquidity made
against the bank.
 Secondary reserves consist of assets paying some interest
(though much lower than earned on other assets as loans) but
their principal feature is ready marketability. Most Secondary
reserves are marketable securities (short term government
securities) and private securities (commercial paper).
 Both primary and secondary reserves are to keep the bank in
readiness to meet demands for cash (liquidity) from whatever
67
source those demands may arise.
Answers
3. How do the financial statements of major nonbank financial
firms resemble or differ from bank financial statements? Why
do these differences or similarities exist?
 Banks have very similar financial statements to credit
union and savings associations. The only difference may
be in the structure of their loan portfolio. Credit unions
probably have more loans to individuals and savings
associations may have more real estate loans as well as
loans to individuals.

68
Answers
3. How do the financial statements of major nonbank financial
firms resemble or differ from bank financial statements? Why
do these differences or similarities exist?
 More differences exist between banks and other major
competitors. These differences exist because of each
company’s unique function.
 Finance companies have loans but on their balance sheet
they are called accounts receivables. In addition, they
show heavy reliance on money market borrowings instead
of deposits.

69
Answers
3. How do the financial statements of major nonbank financial
firms resemble or differ from bank financial statements? Why
do these differences or similarities exist?
 Insurance companies are different in that loans they make
to businesses show up on the balance sheet as bonds,
stocks, mortgages and other securities. On the liability
side, insurance companies receive the majority of their
funds from insurance premiums paid by customers for
insurance protection.

70
Answers
3. How do the financial statements of major nonbank financial
firms resemble or differ from bank financial statements? Why
do these differences or similarities exist?
 Mutual funds hold primarily corporate stocks, bonds,
asset-backed securities and money market instruments
and their liabilities consist primarily of units of the mutual
fund sold to the public.
 Security brokers and dealers tend to hold a similar range
of securities funded by borrowings in the money and
capital markets.

71
Answers
5. Problem 5 (page 157)
a. The dollar figure for Net loans before the charge-off is?
Net Loans = Gross Loans – ALL = $800 - $45 = $755

b. After the charge-off, what are the dollar figures for Gross
loans, ALL and Net loans assuming no other
transactions.
Gross Loans = $800 - $10 = $790
ALL = $45 - $3 = $42
Net Loans = $790- $42 = $748

72
Answers
5. Problem 5 (page 157)
c. If the Mountain View Hotel sells at auction for $8 million,
how with the affect the pertinent balance sheet
accounts?

Gross loans = $800 - $10 = $790

ALL = $45 - $2 = $43
Net loans = $790- $43 = $747

73
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

a. Office supplies are purchased so the bank will have

enough deposit slips and other necessary forms for
customer and employee use next week.

This would be part of Additional noninterest expense and

part of Total noninterest expense.
74
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

b. The bank sets aside funds to be contributed through its

monthly payroll to the employee pension plan in the
name of all its eligible employees.

This would be part of Salaries and benefits and part of

Total noninterest expenses.

75
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

c. The bank posts the amount of interest earned on the

savings account of one of its customers.

This would be part of Total interest expenses.

76
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

d. Management expects that among a series of real estate

loans recently granted the default rate will probably be
close to 3 percent.

This would be part of PLL to go into reserves for future

bad debts.

77
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

e. Mr. And Mrs. Harold Jones just purchased a safety

deposit box to hold their stock certificates and wills.

This would be part of Additional noninterest income and

part of Total noninterest income

78
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

f. The bank colleges $1 million in interest payments from

loans it made earlier this year to Intel Composition
Corp.

This would be part of Total interest income

79
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

g. Hal Jones’s checking account is charged $30 for two of

Hal’s checks that were returned for insufficient funds.

This would be part of Service charges on deposit accounts

and then part of Total noninterest income

80
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

h. The bank earns $5 million in interest on government

securities it has held since the middle of last year.

This would be part of Total interest income.

81
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

i. The bank has to pay its $5,000 monthly utility bill today
to the local electric company.

This would be part of Premises and equipment expenses

and part of Total noninterest expenses

82
Answers
5. Problem 6 (page 157)
For each of the following transactions, which items on a
bank’s statement of income and expenses (Report of
Income) would be affected?

j. A sale of government securities has just netted the bank

a $290,000 capital gain (net of taxes).

This would be part of Security gains (Losses)

83
 Answers
5. Problem 11 (page 159)
Total interest income (TII) and Total interest expense(TIE):

TII = 2TIE and Net interest income = TII –TIE = $800 so:
2TIE –TIE = $800 TIE = $800 and TII = 2($800) = $1,600

Total noninterest income (TNI) and Total noninterest

expense (TNE):
TNI = 0.75TNE and Net noninterest income = TNI – TNE = -
$500, so:
0.75TNE – TNE = -$500
-0.25TNE = $500 TNE = $2,000
84
TNI = 0.75($2,000) = $1,500
 Answers
5. Problem 11 (page 159)
Provision for Loan Losses
PLL = 0.03*Total Interest Income = 0.03*($1,600) = $48

Taxes
Net income before taxes = (Net interest income + Net
noninterest income – PLL)
Net income before taxes = $800 - 500 - $48 = $252
Income before extraordinary items =
Net income before taxes = $252 + $100 = $352
Taxes = 0.3* Net income before taxes = 0.3*352 = $105.60
85
Answers
5. Problem 11 (page 159)

Dividends
Net income after taxes = Net income before taxes - Taxes
Net income after taxes = $352 - $105.60 = $246.4
Increase in undivided profit = Net income after taxes –
Dividends
Dividends = Net income after taxes – Increase in undivided
profit
Dividends= $246.4 - $200 = $46.4

86
 FINANCIAL STATEMENTS
OF BANKS

Chapter 2

William Chittenden edited and updated the PowerPoint slides for this edition.