аЯрЁБс>ўџ PRўџџџOџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџџьЅСY ПЃ,bjbjѓWѓW %l‘=‘=Ѓ(џџџџџџ]ŒŒŒŒŒŒŒ      Ќ, сЖІЈЈЈЈЈЈ$—є‹ œЬŒЬШŒŒШШШњŒŒІ  ŒŒŒŒІШ<ШB\ŒŒІи,`еП*Ј‰Р  ўЪžPresentation of Bank Financial Statements Balance sheet (Report of Condition) Assets Cash assets: e.g.) cash, deposits at the Federal Reserve Interest-bearing bank balances: e.g) short-term CD at other banks, federal funds sold (mainly temporary loans made to other banks, securities dealers, or even major corporations. The funds for these temporary loans come from the reserves a bank has on deposit with the federal reserve bank in its district) Securities: e.g.) U.S. Treasury securities, Municipal securities Loans: the least liquid of banking assets and the major source of risk. The primary source of bank earnings. Loan-loss reserve: an allowance on a bank’s balance sheet that reflects the bank’s estimate of potential loan losses Liabilities Deposits: Noninterest-bearing demand deposits (regular checking accounts): transactions accounts payable to the depositor on demand and pay no interest Savings deposits: generally bear lowest rate of interest but may be of any denomination NOW (Negotiable Order of Withdrawal) accounts: an interest-bearing checking account. Held only by individuals and nonprofit institutions. MMDAs (Money Market Deposit Accounts): savings accounts on which the bank pays market interest, and check writing is limited. Time deposits: fixed maturity and any denomination. Included are negotiable CDs (fixed-maturity interest-bearing deposits with face values over $100,000 that can be resold in the secondary market). Nondeposit Federal funs purchased: the bank’s temporary borrowings in the money market, mainly from reserves loaned to it by other banks (federal funds purchased) Capital Banks are among the most heavily leveraged of all businesses. Their capital accounts normally represent less than 10 percent of the value of their total assets. Par value of all common and preferred stock, additional paid-in capital, loan loss reserves, subordinated notes and debentures (debt securities that are long-term and carry a claim on the bank’s assets and income that comes after the claims of its depositors) , Income Statement (Report of Income) Interest income: primary sources (about two-thirds or more) of bank income; interest income from loans, securities, and federal funds sold Noninterest income (fee income): service charges on deposits, trading accounts, and other foreign transactions; recently, bankers have targeted this fee income as a key source of future revenues. Note that the relative importance of interest income versus fee income is changing rapidly, with fee income today growing much faster than interest income on loans as banks work to develop fee-based services. Interest expenses: largest expense for banks; interest paid on federal funds purchased, time deposits, and etc; interest on short-term debt such as federal funds purchased was just over 15 percent of the bank’s total expenses in the most recent year. Noninterest expenses: overhead expenses such as salaries and provision for loan losses Analyzing Bank Performance with Financial Ratios Profit ratios Rate of return on equity: measures overall profitability of the bank per dollar of equity ROE = NI/TE (net income after taxes/total equity) Rate of return on assets: measures profit generated relative to the bank’s assets ROA = NI/TA (net income after taxes/total assets) ROE and ROA are both measures of profitability, though ROE focuses on the return to the owner’s investment while ROA emphasizes the return on the assets under management. Insured depositors are interested in the profitability of the bank since it is that profitability that determines the stability of the organization. While the failure of the bank would not endanger their deposits (though it would for uninsured depositors), it might disrupt their financial relationships and reduce the quality of those relationships. For shareholders, profitability is vital, particularly as measured by ROE, since it makes possible the payments of cash dividends and affects directly the market value of their equity interest. For managers, the ROA (less so the ROE) is a measure of how successful they have been in deploying the assets under their control. Many performance bonus arrangements tie the size of the bonus to the bank’s profitability. Moreover, senior managers often are significant shareholders, especially at small banks. Other profit measures Net interest margin (NIM) = (Total interest income - Total interest expense)/Total assets where total interest income is on a pretax basis. It measures how large a spread between interest revenues and interest costs management has been able to achieve by close control over the bank’s earning assets and the pursuit of the cheapest sources of funding. Note: Since municipal interest income is free of federal income tax, the percentage return on municipal securities is less than on comparable taxable securities. To make comparisons then of the Net Interest Margin of a bank with other banks (which may have a different mix of taxable versus tax exempt interest income) or of one bank over time (since the mix of taxable versus tax exempt interest income may change over time) it is necessary to state the municipal interest revenue on the basis of its tax equivalent yield. So, municipal bond interest must be grossed up to a pre-tax equivalent basis by dividing municipal interest earned by the factor (1 - tax rate of bank). Profit ratios Unraveling profit ratios ROE = ROA x TA/TE (total assets/total equity or equity multiplier). Equity multiplier measures the extent to which assets of the bank are funded with equity relative to debt. Thus, by decreasing equity, a bank can increase ROE based on any given level of ROA. ROE = NI/OR x OR/TA x TA/TE (where OR is operating revenue) OR is the sum of interest income and non-interest income. The NI/OR ratio is the profit margin; measures the ability to pay expenses and generate net income from interest and non-interest income OR/TA reflects asset utilization; measures the amount of interest and non-interest income generated per dollar of total assets. By using this breakdown, one can make inferences concerning the reason for say increases in ROE. If asset utilization and equity multiplier did not change, the profit margin must have increased due to cost savings pushing this ratio up. Q:If a bank has a relatively low ROA but a relatively high ROE, what factor would explain this difference? Show an equation to demonstrate your answer. ANSWER: A relatively low ROA may be turned into a relatively high ROE if the bank has a high equity multiplier (that is, a low ratio of equity to assets). For example, consider a bank that has an ROA of 0.5 when peer banks have ROA’s that average 1.0. If that bank has a ratio of equity to assets of 4%, then its ROE will be 12.5%. This is obtained from the following: ROE:ROAxEM where ROE: Return on Equity, ROA: Return on Assets, EM: Equity multiplier (inverse of the ratio of equity to assets). For the peer bank, assuming a ratio of equity to assets of 10%, its ROE would be less, only 10%. Risk ratios Capitalization: a high equity multiplier can increase ROE and the growth rate of the bank as long as ROA is positive. On the downside, if ROA were negative, ROE would be magnified in a negative direction. Q: If federal regulations require that bank capital by increased to at least 10 percent of total assets, how would bank growth be affected? ANSWER: With a higher minimum equity capital ratio, the size of commercial banks would be less than with a lower capital ratio. Gradually increasing the minimum capital ratio would reduce the potential growth rate or banks. Asset quality 1.Provision for loan loss ratio = PLL/TL (provision for loan losses/total loans and leases) how much of an expense the bank has set aside for future loan losses on loans 2. Loan ratio = Net loans/Total assets the extent to which assets are devoted to loans as opposed to other assets, including cash, securities, and plant and equipment. 3. Loss ratio = Net charge-offs on loans (gross charge-offs minus recoveries from previous loan charge-offs) / Total loans and leases Loan charge-offs are usually deducted from the Allowance (Reserve) for Loan Losses and do not directly affect bank profits. However, since banks must maintain an adequate allowance account, at some point they must replenish the allowance by provisions for loan losses, which is an expense and does reduce reported profits. 4. Nonperforming ratio = Nonperforming assets /Total loans and leases nonperforming assets: loans that are 90 days or more past due or are not accruing interest. Operating efficiency (cost control) Dealing with the production of outputs at a minimum cost per dollar Wage and salaries expense ratio = Wages and salaries/Total expense Occupancy ratio = Fixed occupancy expenses/Total expenses Liquidity Bankers are concerned about the danger of not having sufficient cash and borrowing capacity to meet deposit withdrawals and other cash needs. Faced with liquidity risk, a bank may be forced to borrow emergency funds at excessive cost to cover its immediate cash needs, reducing its earnings. Temporary investments ratio = (Fed funds sold + short-term investment securities + Due from banks)/Total assets Temporary investments are a bank’s most liquid assets. The higher this ratio the greater the bank’s liquidity Volatile liability dependency ratio = (Total volatile liabilities - Temporary investments)/Net loans and leases+long-term securities Volatile liabilities are brokered deposits, jumbo CDs, deposits in foreign offices, federal funds purchased, and other borrowings This ratio gives an indication of the extent to the riskiest assets are being funded by unstable or “hot” money funds that can disappear from the bank overnight. This ratio varies inversely with liquidity. The negative ratio indicates that some of temporary assets are funded with long-term sources of funds. 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