ANALYZING BANK PERFORMANCE

5-2

Key Topics
• An Overview of the Balance Sheets and Income
Statements of Banks
• The Balance Sheet or Report of Condition
▫ Asset Items
▫ Liability Items
• Components of the Income Statement: Revenues
and Expenses
• Stock Values and Profitability Ratios
• Measuring Credit, Liquidity, and Other Risks
• The UBPR and Comparing Performance

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 5-3

Bank Financial Statements

• Report of Condition – Balance Sheet

• Report of Income – Income Statement

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 Key Items on Bank Financial Statements

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 5-5

Report of Condition

• The Balance Sheet of a Bank Showing its

Assets, Liabilities and Net Worth at a given
point in time

• May be viewed as a list of financial inputs

(sources of funds) and outputs (uses of
funds)

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Report of Condition (Balance Sheet) for BB&T (Year-End
2008 and 2009)

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 5-7

C + S + L + MA = D + NDB + EC

C = Cash Assets
D = Deposits
NDB = Nondeposit
S = Security Holdings Borrowings
L = Loans EC = Equity Capital
MA = Miscellaneous Assets

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 5-8

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
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 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

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 5-10

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
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 5-11

Trading Account Assets

• Securities purchased to Provide Short-Term

Profits from Short-Term Price Movements
• When the Bank Acts as a Securities Dealer
• Valued at Market – FASB 115

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 5-12

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

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 5-13

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

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 5-14

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

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 5-15

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

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 5-16

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
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 5-17

Miscellaneous Assets

• Bank Premises and Fixed Assets

• Other Real Estate Owned (OREO)

• Goodwill and Other Intangibles

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 5-18

Deposit Accounts

• Non interest-Bearing Demand Deposits

• Savings Deposits
• Now Accounts
• Money Market Deposit Accounts (MMDA)
• Time Deposits

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 5-19

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

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 5-20

Equity Capital

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

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 The Composition of Bank Balance Sheets (Percentage Mix of
Sources and Uses of Funds for (Year-End 2009)

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 5-22

Off-Balance-Sheet Items

• Unused Commitments
• Standby Credit Agreements
• Derivative Contracts
▫ Futures Contracts
▫ Options
▫ Swaps
• OBS Transactions Exposure a Firm to
Counterparty Risks

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Examples of Off-Balance-Sheet Items Reported by FDIC-
Insured Banks

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 5-24

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
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 5-25

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
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 5-26

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
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Report of Income (Income Statement) for BB&T (2008 and
2009)

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 5-28

Net Interest Income =

Interest Income – Interest Expenses
Interest Income Interest Expenses
• Interest and Fees on Loans • Deposit Interest Costs
• Taxable Securities Revenue • Interest on Short-Term
• Tax-Exempt Securities Debt
Revenue • Interest on Long-Term Debt
• Other Interest Income

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 5-29

Net Noninterest Income =

Noninterest Income – Noninterest Expenses

Noninterest Income Noninterest Expenses

• Fees Earned from Fiduciary • Wages, Salaries, and
Activities Employee Benefits
• Service Charges on Deposit
Accounts • Premises and Equipment
Expense
• Trading Account Gains and
Fees • Other Operating Expenses
• Additional Noninterest
Income

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 5-30

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

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 5-31

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

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 5-32

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

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 5-33

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
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The Composition of Bank Income Statements (Percentage of
Total Assets Measured as of Year-End 2009)

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 6-35

Key Profitability Ratios in Banking

Net Income
Return on Equity Capital (ROE) =
Total Equity Capital
Net Income
Return on Assets (ROA) =
Total Assets
(Interestincome
- Interestexpense) Net Interest Income
Net Interest Margin  
Total Assets Total Assets

Noninterest revenue
- PLLL
- Noninterest expenses Net Noninterest Income
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Net Noninteres  Companies, Inc., All Rights
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Bank Management and Financial Services, 7/e Total Assets
Reserved. Total Assets
 6-36

Key Profitability Ratios in Banking (cont.)

Total Operating Revenues -

Total Operating Expenses
Net Bank Operating Margin 
Total Assets

Net IncomeAfter Taxes

Earnings Per Share (EPS) 
Common Equity Shares Outstanding

Total Interest Income __ Total Interest Expense

Earnings Spread = Total Earning Assets Total Interest Bearing Liability

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 6-37

Breaking Down ROE

ROE = Net Income/ Total Equity Capital

ROA = Equity Multiplier =

Net Income/Total Assets x Total Assets/Equity Capital

Net Profit Margin = x Asset Utilization =

Net Income/Total Operating Revenue Total Operating Revenue/Total Assets
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 6-38

ROE Depends On:

• Equity Multiplier=Total assets/Total equity capital
▫ Leverage or Financing Policies: the choice of
sources of funds (debt or equity)

• Net Profit Margin=Net income/Total operating

revenue
▫ Effectiveness of Expense Management (cost
control)

• Asset Utilization=Total operating revenue/Total

assets
▫ Portfolio Management Policies (the mix and yield
on assets)
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 Components of Return on Equity (ROE) for All FDIC-
Insured Institutions (1992-2009)

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 6-40

Breakdown of ROA

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 Bank Performance Model Rate
Composition (mix)
Interest
Returns to
Shareholders Volume
ROE = NI / TE INCOME
Fees and Serv Charge
Non Interest Trust
Other
Return to the Bank
ROA = NI / TA
Rate
Interest
Composition (mix)
Volume
EXPENSES
Salaries and Benefits
Overhead
Occupancy
Degree of Leverage
Prov. for LL Other
EM =1 / (TE / TA)
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Taxes
 6-42

Other Goals in Banking

Total Operating Expenses
Operating Efficiency Ratio =
Total Operating Revenues

Net Operating Income

Employee Productivity Ratio =
Number of Full Time-Equivalent Employees

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 6-43

Bank Risks

• Credit Risk • Legal and

• Liquidity Risk Compliance Risk
• Market Risk • Reputation Risk
• Interest Rate Risk • Strategic Risk
• Operational Risk • Capital Risk

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 6-44

Credit Risk
The Probability that Some of the Financial Firm’s
Assets Will Decline in Value and Perhaps Become
Worthless

Credit Risk Measures

• Nonperforming Loans/Total Loans
• Net Charge-Offs/Total Loans
• Provision for Loan Losses/Total Loans
• Provision for Loan Losses/Equity Capital
• Allowance for Loan Losses/Total Loans
• Allowance for Loan Losses/Equity Capital
• Nonperforming Loans/Equity Capital
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 6-45

Liquidity Risk
Probability the Financial Firm Will Not Have
Sufficient Cash and Borrowing Capacity to Meet
Deposit Withdrawals and Other Cash Needs

Liquidity Risk Measures

• Purchased Funds/Total Assets
• Net Loans/Total Assets
• Cash and Due from Banks/Total Assets
• Cash and Government Securities/Total Assets

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 6-46

Market Risk: Comprises Price Risk

and Interest Rate Risk
Probability of the Market Value of the Financial
Firm’s Investment Portfolio Declining in Value Due
to a Change in Interest Rates

Market Risk Measures

• Book-Value of Assets/ Market Value of Assets
• Book-Value of Equity/ Market Value of Equity
• Book-Value of Bonds/Market Value of Bonds
• Market Value of Preferred Stock and Common Stock

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 6-47

Interest Rate Risk

The Danger that Shifting Interest Rates May
Adversely Affect a Bank’s Net Income, the Value of
its Assets or Equity

Interest Rate Risk Measures

• Interest Sensitive Assets/Interest Sensitive
Liabilities

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 6-48

Capital Risk
Probability of the Value of the Bank’s Assets
Declining Below the Level of its Total Liabilities.
The Probability of the Bank’s Long Run Survival

Capital Risk Measures

• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets

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 6-49

Off-Balance-Sheet Risk
The Volatility in Income and Market Value of Bank
Equity that May Arise from Unanticipated Losses
due to OBS Activities (activities that do not have a
balance sheet reporting impact until a transaction
is affected)
Operational Risk
Uncertainty Regarding a Financial Firm’s Earnings
Due to Failures in Computer Systems, Errors,
Misconduct by Employees, Floods, Lightening
Strikes and Similar Events or Risk of Loss Due to
Unexpected Operating Expenses

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 6-50

Legal and Compliance Risk

Risk of Earnings Resulting from Actions Taken by
the Legal System. This can Include Unenforceable
Contracts, Lawsuits or Adverse Judgments.
Compliance Risk Includes Violations of Rules and
Regulations
Reputation Risk
This is Risk Due to Negative Publicity that can
Dissuade Customers from Using the Services of the
Financial Firm. It is the Risk Associated with Public
Opinion.

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 6-51

Performance Indicators Related to

the Size of a Firm, 2007

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Appendix: Using Financial Ratios and Other Analytical
Tools to Track Financial-Firm Performance – The UBPR
and BHCPR
• Compared to other financial institutions, more information is
available about banks than any other type of financial firm
• Through the cooperative effort of four federal banking agencies –
the Federal Reserve System, the Federal Deposit Insurance
Corporation, the Office of Thrift Supervision, and the Office of the
Comptroller of the Currency – the Uniform Bank Performance
Report (UBPR) and the Bank Holding Company Performance
Report (BHCPR) provide key information for financial analysts
• The UBPR, which is sent quarterly to all federally supervised
banks, reports each bank’s assets, liabilities, capital, revenues, and
expenses, and the BHCPR is similar for BHCs
• Web link for UBPR and BHCPR: www.ffiec.gov

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