ECON3610

Money and Banking

Lecture Topic 8

The Financial Statements of Banks

Readings: Rose and Hudgins: Ch. 5

Summary
What is a Banks Balance Sheet?
Bank Assets and Liabilities
Off-Balance sheet Activities
The Problem of Book-Value Accounting
and Window Dressing
What is an Income statement?
Examples

5-4

Introduction
The particular 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
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 rely upon are
The balance sheet (Report of Condition)
The income statement (Report of Income)

5-5

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 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
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
financial firm for future growth and some of which will flow to
stockholders as dividends

Report of Condition
The Balance Sheet of a Bank
Showing its Assets, Liabilities
and Net Worth

5-7

TABLE 51 Key Items on Bank Financial Statements

5-8

The 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 the 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 funds the owners contribute

(EC)

5-9

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 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 that 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 incurs

5-10

The Balance Sheet (Report of Condition) (continued)

One useful way to view the 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 interest to
its depositors, and compensate its employees for their labor and skill

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

5-11

TABLE 53 Report of Condition (Balance Sheet) for BB&T

(Year-End 2008 and 2009)

Bank Assets
Cash Assets
Security Holdings
Loan Accounts
Miscellaneous Assets

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

5-14

Investment Securities
Investment Securities - The Liquid Portion
Short Term Government Securities
Privately Issued Money Market Securities
Interest Bearing Time Deposits
Commercial Paper

Often called secondary reserves

Investment Securities
These are the Income Generating Portion of
Securities
Taxable Securities
U.S. Government Notes
Government Agency Securities
Corporate Bonds

Tax-Exempt Securities
Municipal Bonds

Trading Account Assets

Securities purchased for to Provide ShortTerm Profits from Short-Term Price
Movements
When the Bank Acts as a Securities Dealer
Valued at Market

Federal Funds Sold and Reverse

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
Customers liabilities on acceptance

Loan Accounts
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

Types of Loans
Commercial and Industrial Loans
Consumer Loans (Loans to Individuals)
Real Estate Loans
Financial Institution Loans
Foreign Loans
Agriculture Production Loans
Security Loans
Leases

Allowance for Loan Losses

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

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

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

Bank Liabilities
Deposit Accounts
Nondeposit Borrowings
Capital Accounts

Deposit Accounts
Non interest-Bearing Demand Deposits
Savings Deposits
Now Accounts
Money Market Deposit Accounts (MMDA)
Time Deposits

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

Equity Capital
Preferred Stock
Common Stock
Common Stock Outstanding
Capital Surplus
Retained Earnings (Undivided Profits)
Treasury Stock
Contingency Reserve

5-27

TABLE 5-4 The Composition of Bank Balance Sheets (Percentage

Mix of Sources and Uses of Funds for (Year-End 2009)

Off-Balance-Sheet Items
Unused Commitments
Standby Credit Agreements
Derivative Contracts
Futures Contracts
Options
Swaps

5-29

TABLE 55 Examples of Off-Balance-Sheet Items Reported

by FDIC-Insured Banks

5-30

Possible Issues

The Problem with Book-Value Accounting

Original (historical, book-value) cost
Amortized cost
Market-value
Held-to-maturity and available-for-sale securities

Window Dressing
Auditing Financial Statements
Audit Committees
Sarbanes-Oxley Accounting Standards Act

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

5-32

Components of the Income Statement (Report

of Income) (continued)

The Income Statement or The Statement of Earnings and Expenses (Report of Income)
Revenue (financial Outputs from making use of funds and other resources to produce and sell services)
Interest income from loans and investments
Noninterest income (fee income from miscellaneous sources)

Expenses (financial inputs the cost of acquiring funds and other resources needed for the sales of
services)
Interest paid on deposits
Interest paid on nondeposit borrowings
Salaries and wages (employee compensation)
Provision for loan losses (allocation to reserves for loan losses)
Other expenses

Pretax net operating income (revenues expenses listed above)

Taxes
Gains or losses from trading in securities

Net income (Pretax net operating income taxes + securities gains securities losses)

Net Interest Income =

Interest Income Interest Expenses
Interest Income

Interest Expenses

Interest and Fees on Deposit Interest

Loans
Costs
Taxable Securities Interest on ShortRevenue
Term Debt
Tax-Exempt
Interest
on
LongSecurities Revenue
Term
Debt
Other Interest
Income

5-35

TABLE 56 Report of Income (Income Statement) for BB&T

(2008 and 2009)

Net Noninterest Income =

Noninterest Income Noninterest Expenses
Noninterest Income
Fees Earned from
Fiduciary Activities
Service Charges on
Deposit Accounts
Trading Account Gains
and Fees
Additional Noninterest
Income

Noninterest Expenses

Wages, Salaries, and

Employee Benefits
Premises and
Equipment Expense
Other Operating
Expenses

Fees Earned from Fiduciary

Activities
Fees for Managing Protecting a Customers
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

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

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

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 ales of Real Estate
Net Gains (Losses) on the Sales of Other Assets

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

5-42

TABLE 57 The Composition of Bank Income Statements

(Percentage of Total Assets Measured as of Year-End 2009)

5-43