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  1. Chapter Three The Financial Statements of Banks and Their Principal Competitors

  2. 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 • The Problem of Book-Value Accounting and “Window Dressing” • Components 部件 of the Income Statement: Revenues and Expenses • Appendix: Sources of Information on the Financial-Services Industry

  3. Introduction p. 57 • Theservices 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)

  4. An Overview of Balance Sheets and Income Statements p. 57-59 • The Report of Condition • Types of assets or funds sources (financial inputs) needed to finance lending and investing activities and how much has been allocated 分配 (fēnpèi) to loans, securities, and other funds uses (financial outputs) or the liabilities and equity. • In contrast, the financial inputs and outputs on the Report of Income show how much it has cost to get funds and to generate revenues from the uses the financial firm has made of those funds.

  5. An Overview of Balance Sheets and Income Statements continued p. 57-59 • The Report of Income shows the revenues (cash flow) made by selling services to the public, including making loans and servicing customer deposits • The Report of Income 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

  6. TABLE 5–1 Key Items on Bank Financial Statements p. 58

  7. 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

  8. The Balance Sheet (Report of Condition) 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) • Nondepositborrowings of funds in the money and capital markets (NDB) • Equity capital represents long-term funds the owners contribute (EC)

  9. The Balance Sheet (Report of Condition) • Cash assets (C) are designed 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 principally to supply income p. 62-63 • Miscellaneous 杂项 (záxiàng)assets (MA) are fixed assets (plant and equipment) and investments in subsidiaries (if any)

  10. The Balance Sheet (Report of Condition) p. 59 • Deposits (D) are typically the main source of funding for banks p.66 • Nondeposit borrowings (NDB) are carried out mainly to supplement 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 rely to grow and to cover any extraordinary 非凡 (fēifán) losses it incurs. Comes from shareholders 股东 (gǔdōng) p. 67-68

  11. 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 the needed spending power to acquire, to get assets • A bank’s assets are its accumulated 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:

  12. TABLE 5–2 Highlighted Bank Financial Data ($ million) from the FDIC (December 31, 2009) p. 60

  13. TABLE 5–3 Report of Condition (Balance Sheet) for BB&T (Year-End 2008 and 2009) p. 61

  14. 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

  15. The Balance Sheet (Report of Condition) (continued) 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

  16. The Balance Sheet (Report of Condition) (continued) p. 61 • Investment Securities - The Income-Generating Portion • Taxable Securities • U.S. Government Notes • Government Agency Securities • Corporate Bonds • Tax-Exempt Securities • Municipal Bonds

  17. The Balance Sheet (Report of Condition) 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 • “Fed funds”

  18. The Balance Sheet (Report of Condition) (continued) p. 62 • Loan Accounts • The Major Asset • Gross Loans – Sum of All Loans • Allowance for Possible Loan Loss • Net Loans • Unearned Discount Income • Nonperforming Loans

  19. The Balance Sheet (Report of Condition) (continued) 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)

  20. The Balance Sheet (Report of Condition) (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

  21. The Balance Sheet (Report of Condition) (continued) 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

  22. The Balance Sheet (Report of Condition) (continued) p. 66 • Miscellaneous Assets • Bank Premises and Fixed Assets • Other Real Estate Owned (OREO) • Goodwill and Other Intangibles

  23. 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

  24. 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) • Acceptances Outstanding • Eurocurrency Borrowings • Subordinated Debt • Limited Life Preferred Stock • Other Liabilities

  25. 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

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

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

  28. The Balance Sheet (Report of Condition) (continued) p. 70-71 • The Problem with Book-Value Accounting • Original (historical, book-value) cost • Amortized 缓冲 ( huǎnchōng) cost • Market-value • Held-to-maturity and available-for-sale securities • Window Dressing • Auditing Financial Statements • Required to file with the FDIC or a state agency • Audit 审计 (shěnjì) Committees • Sarbanes-Oxley Accounting Standards Act - Requires financial firms to certify, or make good their financial reports.

  29. 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 specific period of time • Shows how much it has cost to get funds and to generate revenues from the uses of funds in the 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

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

  31. 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 sections • Interest income • Interest expenses • Noninterest income • Noninterest expenses

  32. TABLE 5–6 Report of Income (Income Statement) for BB&T (2008 and 2009) p. 74

  33. 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

  34. 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 Fiduciary Activities • 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

  35. The Financial Statements of Leading Nonbank Financial Firms: A Comparison to Bank Statements p. 79 • The financial statements of nonbank financial firms have, in recent years, come closer and closer to what we see on bank statements • Especially true of thrift institutions • Thrifts’ balance sheet loans, deposits from customers, and borrowings in the money market • Thrifts’ income statements are revenue from loans and by the interest they must pay on deposits and money market borrowings • Other groups in the financial-service industries such as finance companies, life and property/casualty insurers, mutual funds, and security brokers and dealers • Their financial statements include sources and uses of funds unique to the functions of these industries

  36. An Overview of Key Features of Financial Statements and Their Consequences • Table 5–8 provides a useful overview of the key features of the financial statements of financial institutions and their consequences for the managers of financial firms and for the public

  37. TABLE 5–8 Features and Consequences of the Financial Statements of Banks and Similar Financial Firms

  38. Quick Quiz • What are the principal accounts that appear on a bank’s balance sheet (Report of Condition)? • Which accounts are most important and which are least important on the asset side of a bank’s balance sheet? What accounts are most important on the liability side of a balance sheet? • What are primary reserves and secondary reserves, and what are they supposed to do? • What accounts make up the Report of Income (income statement of a bank)? • What is the relationship between the provision for loan losses on a bank’s Report of Income and the allowance for loan losses on its Report of Condition? • What are the key features or characteristics of the financial statements of banks and similar financial firms?

  39. HOMEWORK • Divide up the 6 quiz questions among your group and as a group turn in answers to all 6 questions and know all the answers as a study group.

  40. 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 or expense statement, Report of Income. • Balance sheet reports value of assets, liabilities and stockholders’equity. These include cash, investments and loans.

  41. CHAPTER SUMMARY (continued) • The Report of Income 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.

  42. PROBLEMS AND PROJECTS to be done in class 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.