William Chittenden edited and updated the PowerPoint slides for this edition. FINANCIAL STATEMENTS OF BANKS Chapter 2 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 Bank financial statements  Report of condition – Balance sheet  Report of income – Income statement 5-4 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) C + S + L + MA = D + NDB + EC C = Cash assets S = Security holdings L = Loans MA = Miscellaneous assets D = Deposits NDB = Non-deposit borrowings EC = Equity capital 5-6 Balance sheet 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 Balance Sheet (assets): PNC and Community National Bank 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) 5-9 Securities: the liquid portion  Often called secondary reserves, include:  Short term government securities  Privately issued money market securities  Interest bearing time deposits  Commercial paper 5-10 [...]... contracts  Options  Swaps  Off-balance-sheet transactions exposure a firm to counterparty risks 5- 32 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 23 4-year-old Barings Bank in 1995 by Nicholas Leeson... http://www.time.com/time /20 07/crimes/18.html 5-33 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... the bulk of interest-bearing liabilities at banks 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... Size Banks (FDIC, 20 06) Which accounts are most important on the asset side of a Call Report? Liability side? 5-31 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. .. holdings; no income statement impact Bank investments and FASB 115 amortized cost, market value (fair value) http://books.google.com.vn/books? id=c3f0AegbDx4C&pg=PA 221 &lpg=PA 221 &dq=amortized+ cost&source=bl&ots=PYzqn9tqrJ&sig=0qSsODiLgsl3_fDOZ JWo91L4Zu8&hl=vi&ei=RfKHS6PBKNegkQWUgrmhDw& sa=X&oi=book_result&ct=result&resnum=7&ved=0CCUQ6 AEwBg#v=onepage&q=amortized %20 cost&f=false 5-16 Loan accounts ... (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 Balance Sheet (liabilities): PNC and Community National Bank 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... Allowance for loan losses 5 -20 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 Decision 493 /20 05/QD-NHNN Provisions for loan losses Recoveries Provisions for loan losses Reserve for Loan Losses Charge offs Average assets, capital... data: PNC and Community NB 5 -23 Miscellaneous assets  Bank premises and fixed assets  Other real estate owned (OREO)  Goodwill and other intangibles 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... portion of securities  Taxable securities  U.S Government notes  Government agency securities  Corporate bonds  Tax-exempt securities  Municipal bonds 5- 12 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 Federal funds sold and reverse repurchase agreements 5-13  A type of. .. 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 5-19 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 . edition. FINANCIAL STATEMENTS OF BANKS Chapter 2 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. Recent expansion of off-balance sheet items 4. 4. Components of the Income statement: Revenues and Expenses 5. 5. Financial statement manipulation Bank financial statements  Report of condition. income statement impact. Bank investments and FASB 115 amortized cost, market value (fair value) http://books.google.com.vn/books? id=c3f0AegbDx4C&pg=PA 221 &lpg=PA 221 &dq=amortized+ cost&source=bl&ots=PYzqn9tqrJ&sig=0qSsODiLgsl3_fDOZ JWo91L4Zu8&hl=vi&ei=RfKHS6PBKNegkQWUgrmhDw& sa=X&oi=book_result&ct=result&resnum=7&ved=0CCUQ6 AEwBg#v=onepage&q=amortized %20 cost&f=false