FINANCIAL

STATEMENTS OF BANKS

Chapter 2

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 7

receivable, prepaid expenses, other real estate

Balance Sheet (assets): PNC and Community National
Bank PNC BANK, NATIONAL ASSOCIATION COMMUNITY NATIONAL BANK
Dec-03 % of Dec-04 % of Dec- % of Dec- % of
BALANCE % 1,00 Total % Cha 1,00 Total % 03 Total % Cha 04
SHEET
ASSET Cha 0 0 Cha 1,00 1,00 Tota
S Loans: 0 0 l
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% - 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% 5.8% 8,454 4.4% -5.2% 8,011 3.8%
Agricultural loans 9.2% 984 0.0% 57.0% 1,545 0.0% 26.7% 0 0.0% 0.0% 0 0.0%
Other LN&LS in domestic -20.5% 3,022,795 4.9% - 2,999,113 4.1% 0.0% 26 0.0% 284.6% 100 0.0%
off. LN&LS in foreign off. 15.6% 1,190,025 1.9% 0.8% 1,222,904 1.7% 13.0% 0 0.0% 0.0% 0 0.0%
Gross Loans & Leases -4.6% 34,234,025 55.2% 2.8% 43,449,785 58.9% 0.0% 118,092 61.3% 11.7% 131,877 62.8%
Less: Unearned 8.0% 44,867 0.1% 26.9% 44,949 0.1% 2.2% 0 0.0% 0.0% 0 0.0%
Income -4.6% 34,189,158 55.1% 0.2% 43,404,836 58.8% 0.0% 118,092 61.3% 11.7% 131,877 62.8%
Memo: Total loans -5.8% 606,886 1.0% 27.0% 583,915 0.8% 2.2% 1,258 0.7% 28.5% 1,617 0.8%
Loan & Lease loss -4.5% 54.1% - 58.0% 6.7% 60.6% 11.5% 130,260 62.0%
33,582,272 42,820,921 116,834
Allowance Net Loans & 3.8% 2.2%
Leases 90.6% 5,574,108 9.0% 27.5%
15.9% 6,460,936 8.8% 73.9% 34,937 18.1% 24.8% 43,591 20.7%
Investments: -46.9% 7,719 0.0% 1606.0% 131,685 0.2% - 613 0.3% -0.5% 610 0.3%
U.S. Treasury & Agency -100.0% 0 0.0% 0% 0 0.0% 0.5% 0 0.0% 0% 0 0.0%
securitie Municipal securities 1.1% 8,804,028 14.2% 3.0% 9,064,146 12.3% 0.0 2,104 1.1% -2.2% 2,057 1.0%
Foreign debt 16.4% 259,318 0.4% 51.8% 393,713 0.5% % 4,428 2.3% -57.5% 1,881 0.9%
securities All other -54.6% 1,106,733 1.8% 56.2% 1,728,372 #N/A
2.3% 175.0% 7,000 3.6% -21.4% 5,500 2.6%
securities -9.1% 935,042 1.5% 78.3% 1,667,330 2.3% #N/A
0.0% 0 0.0% 0.0% 0 0.0%
Interest bearing bank balances 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%
Fed funds sold & resales -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%
Trading account assets -6.9% 4.7% 8.5% 4.3% -16.6% 13,083 6.8% -10.7% 11,682 5.6%
2,926,330 3,174,493
Total Investments 24.4% 1.7% 2.5% 1.4% 12.2% 5,642 2.9% 2.2% 5,768 2.7%
1,039,603 1,066,028
Total Earning Assets 21.8% 14,208 0.0% 0.7% 14,3010.0% -84.3% 325 0.2% -100.0% 0 0.0%
252.4% 17,386 0.0% -12.4% 15,2230.0% 0.0% 0 0.0% 0.0% 0 0.0%
Nonint Cash & Due from
51.8% 7,754,149 12.5% -6.2% 7,272,0179.9% 259.8% 7,761 4.0% 13.2% 8,783 4.2%
banks 4.0% 100.0% 19.0% 100.0% 18.6% 100.0 9.0% 100.0%
62,020,896 73,809,165 192,727 210,132
Premises, fixed assets & capital le %
Average Assets
Other real estateDuring
owned 6.8% 62,719,462 101.1 17.0% 73,391,052 99.4% 17.5% 191,480 99.4 9.4% 99.7
Quarter % % 209,525 %
Investment in unconsolidated 8
subs Acceptances and other
 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 9
 5-10

Securities: the liquid portion

■■ Often called secondary reserves, include:

■■ Short term government securities

■■ Privately issued money market

securities

■■ Interest bearing time deposits

■■ Commercial paper

10
 5-11

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
11
 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

12
 5-13

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
13
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.
14
 5-15

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 15
 5-16

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
▪ 16
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.
17
 5-18

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
18

ALL : Allowance for loan losses

 5-19

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 02/2013/TT-NHNN

19
 Provisions for loan losses

Recoveries

Provisions for loan losses

Reserve for Loan Losses Charge offs

20
 Average assets, capital and loan loss data: PNC and Community NB
PNC BANK, NATIONAL ASSOCIATIONCOMMUNITY 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 644,475 606,886 1,179 1,258
Balance at beginning of period 7 6.92% 255,377 1.8% -5.83% 161,537 1.5% 38.87% 616 1.0% 6.70% 260 1.0%
Gross Credit Losses 7 2.40% 26,060 0.7% -36.75% 8,558 0.4% 277.91% 0 0.5% -57.79% 0 0.2%
7 47,453 49,849 11 19
Memo: Loans HFS Writedown 14.01% 0.1% -67.16% 0.0% 0.00% 0.0% 0.00% 0.0%
Recoveries 7 11.29% 207,924 0.1% 5.05% 111,688 0.1% -15.38% 605 0.0% 72.73% 241 0.0%
Net Credit Losses 7 0.56% 176,612 0.6% -46.28% 51,553 0.3% 303.33% 684 0.5% -60.17% 600 0.2%
Provisions for Credit Losses 7 -39.11% (6,277) 0.5% -70.81% 37,164 0.1% 42.50% 0 0.6% -12.28% 0 0.5%
Other Adjustments 7 -84.91% 606,886 0.0% -692.07% 583,915 0.1% 0.00% 1,258 0.0% 0.00% 1,617 0.0%
Balance at end of period 7 -5.83% 1.7% -3.79% 1.5% 6.70% 1.1% 28.54% 1.3%
35,193,158 39,960,849 114,953 123,431
Average Total Loans & Leases 7 -8.74% 100.0% 13.55% 100.0% 5.43% 100.0% 7.38% 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% 210 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%
 5-22

Miscellaneous assets

■■ Bank premises and fixed assets

■■ Other real estate owned

(OREO)

■■ Goodwill and other intangibles

22
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)
■■ Paymarket rates, but a customer is limited to no
more than six checks or automatic transfers
each month
■■ Savings and time deposits represent the bulk 23
interest-bearing liabilities at banks.
 Bank liabilities (cont.)
■■ Two general time deposits categories exist:
■■ Timedeposits in excess of $100,000,
labeled jumbo certificates of deposit (CDs).
■■ SmallCDs, considered core deposits which tend
to be stable deposits that are typically not
withdrawn over short periods of time.
■■ Deposits held in foreign offices
■■ Balancesissued by a bank subsidiary
located outside the U.S.

24
 5-25

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 25
 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 oneliabilities.
net non-core year.* 26

*The UBPR (Uniform Bank Performance Report ) also includes brokered

 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 Total % Cha
1,000 1,000 Total
LIABILITIE
S 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 Money 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%
market deposit accounts Other 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%
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%
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%
Core Deposits
Time deposits of $100M or more -17.6% 1,775,943 2.9% 80.5% 3,205,331 4.3% 4.9% 13,572 7.0% 8.4% 14,714 7.0%
Deposits held in foreign offices 71.5% 2,371,548 3.8% 26.3% 2,994,623 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Total deposits 3.2% 45,548,444 73.4% 16.1% 52,866,018 71.6% 19.3% 177,289 92.0% 9.1% 193,418 92.0%
25.2% 499,232 0.8% 221.8% 1,606,647 2.2% 0.0% 1,000 0.5% 0.0% 1,000 0.5%
Fed funds purchased & resale
898.2% 1,000,000 1.6% -100.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
FHLB borrowings < 1 Yr
99.4% 2,264,921 3.7% 34.5% 3,046,632 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Other borrowings inc mat < 1 yr
73.5% 7,111,124 11.5% 25.7% 8,936,809 12.1% 0.1% 7,901 4.1% 28.7% 10,169 4.8%
Memo: S.T. non core funding 6,911,644
Memo: S.T. Volatile liabilities 36.2% 11.1% 57.0% 10,853,233 14.7% 4.5% 14,572 7.6% 7.8% 15,714 7.5%
-90.0% 115,406 0.2% -23.3% 88,508 0.1% 0.0% 0 0.0% 0.0% 0 0.0%
FHLB borrowings > 1 Yr 1,765,851 3,624,223 0 0
Other borrowings inc mat > 1 yr -2.9% 2.8% 105.2% 4.9% 0.0% 0.0% 0.0% 0.0%
3,864,388 4,585,994 395 520
Acceptances & other liabilities -0.1% 6.2% 18.7% 6.2% -11.0% 0.2% 31.6% 0.2%
4.6% 55,058,242 88.8% 19.5% 65,818,022 89.2% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
Total Liabilities before Sub. No
16.2% 1,340,133 2.2% 41.4% 1,895,482 2.6% 0.0% 0 0.0% 0.0% 0 0.0%
Sub. Notes & Debentures 4.9% 56,398,375 90.9% 20.1% 67,713,504 91.7% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
Total Liabilities
-4.1% 5,622,521 9.1% 8.4% 6,095,661 8.3% 12.0% 14,043 7.3% 8.2% 15,194 7.2%
All common and preferred capital 4.0% 62,020,896 100.0% 19.0% 73,809,165 100.0% 18.6% 192,727 100.0% 9.0% 210,132 100.0%
Total Liabilities & Capital
Memoranda:
Officer, Shareholder Loans (#) 0.0% 2 0.0% 50.0% 3 0.0% -50.0% 1 0.0% 0.0% 1 0.0%
Officer, Shareholder Loans ($) -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% 46,22587 22.0%

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)
28
 5-29

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

- What are the differences among banks according to their size? 29

 5-30

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 30

firmto counterparty risks

 5-31

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
31
 5-32

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 32
 5-33

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

33
Questions

■■ What are total incomes/total expenses?

■■ What are the proportion of each income item

in 2 years? Comment.

■■ What are the proportion of each expense

item in 2 years? Comment.

34
 5-35

Net interest income =

Interest income – Interest expenses
Interest income Interest expenses
▪▪ Interest and fees on ▪▪ Deposit interest
loans and leases costs
▪▪ Deposits held at other ▪▪ Interest on short-term
institutions debt
▪▪ Taxable securities ▪▪ Interest on long-term
revenue debt
▪▪ Tax-exempt securities
revenue 35
 5-36

Net noninterest income =

Noninterest income – Noninterest expenses
Noninterest income Noninterest expenses

▪▪ Fees earned from ▪▪ Wages, salaries, and

fiduciary employee benefits
activities ▪▪ Premises and
▪▪ Service charges on equipment expense
deposit accounts
▪▪ Other operating
▪▪ Trading account gains
expenses
and fees
▪▪ Additional noninterest 36

income
 5-37

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

37
 5-38

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
38
 5-39

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.

39
 5-40

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 40
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 41

 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. 42
 5-43

Income statement
Net interest income
- Provision for loan
loss Net income after
PLL
+/- Net noninterest income
Net income before taxes
Taxes
Net income
- Dividends
43
Undivided profits
 5-44

Comparative Income Statement Ratios for Different Size Banks

(FDIC, 2006)

What are the most important revenue and expense items on the income statement
44
of a bank?
Quick check

■■ Questions 5.10 and 5.11 – page 149.

■■ What are the relationships among items in

Report of Conditions and Report of
Income?
- Drawing the BS and IS in your notebook

- Making the lines among related items

45
 5-46

46
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?

47
 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/articles
/ specpurpentity.htm)
■■ Window dressing
■■ Eliminate Fed borrowing prior to financial
reporting date
statement 48

■■ Increase asset size prior to year-

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?

49
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 50
agency that collects taxes and enforces the internal revenue
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

51
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 52
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
53
withdrawal).
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. 54
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
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.

56
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.

57
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.

58
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.

59
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

60
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

61
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.
62
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.

63
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.

64
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.

65
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

66
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

67
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

68
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.

69
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

70
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)

71
 Answers
5. Problem 11 (page 159)
Total interest income (TII) and Total interest expense(TIE):

TII = 2TIEand 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
TNI = 0.75($2,000) = $1,500
72
 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
73
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

74
 FINANCIAL
STATEMENTS OF BANKS

Chapter 2

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