1、Chapter FiveThe Financial Statements of Banks and Their Principal CompetitorsKey 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 Expansion of Off-Balance-Sheet Items The Prob
2、lem of Book-Value Accounting and“Window Dressing”Components of the Income Statement:Revenues and Expenses Appendix:Sources of Information on the Financial-Services IndustryIntroduction The particular services each financial firm chooses to offer and the overall size of each financial-service organiz
3、ation are reflected in its financial statements Financial statements can be viewed as a“road map”Tell 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
4、rely upon are The balance sheet(Report of Condition)The income statement(Report of Income)An Overview of Balance Sheets and Income Statements The Report of Condition shows the amount and composition of funds sources(financial inputs)drawn upon to finance lending and investing activities and how much
5、 has been allocated to loans,securities,and other funds uses(financial outputs)at any given point in time In contrast,the financial inputs and outputs on the Report of Income show how much it has cost to acquire funds and to generate revenues from the uses the financial firm has made of those funds
6、The Report of Income also shows the revenues(cash flow)generated 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 the sum of all revenues,some of which will be reinvested in the financia
7、l firm for future growth and some of which will flow to stockholders as dividendsTABLE 51 Key Items on Bank Financial Statements The Balance Sheet(Report of Condition)A balance sheet lists the assets,liabilities,and equity capital(owners funds)held by or invested in a bank or other financial firm on
8、 any given dateThe Balance Sheet(Report of Condition)(continued)For banks and other depository institutions the assets on the balance sheet are of four major types:Cash in the vault and deposits held at other depository institutions(C)Government and private interest-bearing securities purchased in t
9、he open market(S)Loans and lease financings 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 fu
10、nds the owners contribute(EC)The Balance Sheet(Report of Condition)(continued)Cash assets(C)are designed to meet the financial firms need for liquidity Security holdings(S)are a backup source of liquidity and include investments that provide a source of income Loans(L)are made principally to supply
11、income Miscellaneous assets(MA)are usually dominated by fixed assets(plant and equipment)and investments in subsidiaries(if any)Deposits(D)are typically the main source of funding for banks Nondeposit borrowings(NDB)are carried out mainly to supplement deposits and provide the additional liquidity t
12、hat cash assets and securities cannot provide Equity capital(EC)supplies the long-term,relatively stable base of financial support upon which the financial firm will rely to grow and to cover any extraordinary losses it incursThe Balance Sheet(Report of Condition)(continued)One useful way to view th
13、e balance sheet identity is to note that liabilities and equity capital represent accumulated sources of funds,which provide the needed spending power to acquire assets A banks assets,on the other hand,are its accumulated uses of funds,which are made to generate income for its stockholders,pay inter
14、est to its depositors,and compensate its employees for their labor and skill Thus,the balance sheet identity can be pictured simply as:TABLE 52 Highlighted Bank Financial Data($million)from the FDIC(December 31,2009)TABLE 53 Report of Condition(Balance Sheet)for BB&T(Year-End 2008 and 2009)The Balan
15、ce Sheet(Report of Condition)(continued)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 reservesThe Balance Sheet(R
16、eport of Condition)(continued)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(Report of Condition)(continued)Investment Securities-The
17、Income-Generating Portion Taxable Securities U.S.Government Notes Government Agency Securities Corporate Bonds Tax-Exempt Securities Municipal BondsThe Balance Sheet(Report of Condition)(continued)Trading Account Assets Securities purchased to provide short-term profits from short-term price movemen
18、ts Occurs when the bank acts as a securities dealer Valued at Market FASB 115The Balance Sheet(Report of Condition)(continued)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
19、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”Some of these temporary credits are extended in the form of reverse repurchase(resale)agreem
20、ents(RPs)in which the banking firm acquires temporary title to securities owned by the borrower and holds those securities as collateral until the loan is paid offThe Balance Sheet(Report of Condition)(continued)Loan Accounts The Major Asset Gross Loans Sum of All Loans Allowance for Possible Loan L
21、osses Contra Asset Account For Potential Future Loan Losses Net Loans Unearned Discount Income Nonperforming LoansThe Balance Sheet(Report of Condition)(continued)Types of Loans Commercial and industrial(or business)loans Consumer(or household)loans Real estate(or property-based)loans Financial inst
22、itutions loans Foreign(or international)loans Agricultural production loans Security loans LeasesThe Balance Sheet(Report of Condition)(continued)Loan Losses Beginning Allowance for Loan Losses+This Years Provision for Loan Loss=Adjusted Allowance for Loan Losses-Actual Charge-Offs of Worthless Loan
23、s+Recoveries from Previous Charge-Offs=Ending Allowance for Loan LossesThe Balance Sheet(Report of Condition)(continued)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 Determine
24、d by management but influenced by taxes and government regulation Loans to lesser developed countries require allocated transfer reservesThe Balance Sheet(Report of Condition)(continued)Miscellaneous Assets Bank Premises and Fixed Assets Other Real Estate Owned(OREO)Goodwill and Other IntangiblesThe
25、 Balance Sheet(Report of Condition)(continued)Liabilities of the Banking Firm Deposits Non interest-Bearing Demand Deposits Savings Deposits Now Accounts Money Market Deposit Accounts(MMDA)Time DepositsThe Balance Sheet(Report of Condition)(continued)Liabilities of the Banking Firm Nondeposit Borrow
26、ings Fed Funds Purchased Securities Sold Under Agreement to Repurchase(Repurchase Agreements)Acceptances Outstanding Eurocurrency Borrowings Subordinated Debt Limited Life Preferred Stock Other LiabilitiesThe Balance Sheet(Report of Condition)(continued)Equity Capital of the Banking Firm Preferred S
27、tock Common Stock Common Stock Outstanding Capital Surplus Retained Earnings(Undivided Profits)Treasury Stock Contingency ReserveTABLE 5-4 The Composition of Bank Balance Sheets(Percentage Mix of Sources and Uses of Funds for(Year-End 2009)The Balance Sheet(Report of Condition)(continued)Recent Expa
28、nsion of Off-Balance-Sheet(OBS)Items in Banking Unused 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 asset
29、s many times overTABLE 55 Examples of Off-Balance-Sheet Items Reported by FDIC-Insured BanksThe Balance Sheet(Report of Condition)(continued)The Problem with Book-Value Accounting Original(historical,book-value)cost Amortized cost Market-value Held-to-maturity and available-for-sale securities Windo
30、w Dressing Auditing Financial Statements Audit Committees Sarbanes-Oxley Accounting Standards ActComponents of the Income Statement(Report of Income)Indicates the amount of revenue received and expenses incurred over a specific period of time Shows how much it has cost to acquire funds and to genera
31、te 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 revenuesComponents of the Income Statement(Report of Income)(continued)Components of the Income
32、Statement(Report of Income)(continued)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.Noni
33、nterest expenses TABLE 56 Report of Income(Income Statement)for BB&T(2008 and 2009)Components of the Income Statement(Report of Income)(continued)Net Interest Income=Interest Income Interest Expenses Interest Income Sources Interest and Fees on Loans Taxable Securities Revenue Tax-Exempt Securities
34、Revenue Other Interest Income Interest Expense Sources Deposit Interest Costs Interest on Short-Term Debt Interest on Long-Term DebtComponents of the Income Statement(Report of Income)(continued)Net Noninterest Income=Noninterest Income Noninterest Expenses Noninterest Income Sources Fees Earned fro
35、m 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 ExpensesThe Financial Statements of Leading Nonbank Financial Firms:
36、A Comparison to Bank Statements 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 are dominated by loans,deposits from customers,and borrowings in the money ma
37、rket Thrifts income statements are heavily tilted toward 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 d
38、ealers Their financial statements include sources and uses of funds unique to the functions of these industriesTABLE 57 The Composition of Bank Income Statements(Percentage of Total Assets Measured as of Year-End 2009)An Overview of Key Features of Financial Statements and Their Consequences Table 5
39、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 publicTABLE 58 Features and Consequences of the Financial Statements of Banks and Similar Financial FirmsQuick Quiz What are t
40、he principal accounts that appear on a banks balance sheet(Report of Condition)?Which accounts are most important and which are least important on the asset side of a banks balance sheet?What accounts are most important on the liability side of a balance sheet?What are primary reserves and secondary
41、 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 banks 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?
