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
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)
 5-6

Balance sheet

C + S + L + MA = D + NDB + EC
C = Cash assets D = Deposits
S = Security holdings NDB = Non-deposit
borrowings
L = Loans
EC = Equity capital
MA = Miscellaneous
assets
 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
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 1,000 Total % Cha 1,000 Total
ASSETS
Loans:
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% -5.8% 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% 26.7% 8,454 4.4% -5.2% 8,011 3.8%
Agricultural loans 9.2% 984 0.0% 57.0% 1,545 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Other LN&LS in domestic off. -20.5% 3,022,795 4.9% -0.8% 2,999,113 4.1% 13.0% 26 0.0% 284.6% 100 0.0%
LN&LS in foreign off. 15.6% 1,190,025 1.9% 2.8% 1,222,904 1.7% 0.0% 0 0.0% 0.0% 0 0.0%
Gross Loans & Leases -4.6% 34,234,025 55.2% 26.9% 43,449,785 58.9% 2.2% 118,092 61.3% 11.7% 131,877 62.8%
Less: Unearned Income 8.0% 44,867 0.1% 0.2% 44,949 0.1% 0.0% 0 0.0% 0.0% 0 0.0%
Memo: Total loans -4.6% 34,189,158 55.1% 27.0% 43,404,836 58.8% 2.2% 118,092 61.3% 11.7% 131,877 62.8%
Loan & Lease loss Allowance -5.8% 606,886 1.0% -3.8% 583,915 0.8% 6.7% 1,258 0.7% 28.5% 1,617 0.8%
Net Loans & Leases -4.5% 33,582,272 54.1% 27.5% 42,820,921 58.0% 2.2% 116,834 60.6% 11.5% 130,260 62.0%
Investments:
U.S. Treasury & Agency securities 90.6% 5,574,108 9.0% 15.9% 6,460,936 8.8% 73.9% 34,937 18.1% 24.8% 43,591 20.7%
Municipal securities -46.9% 7,719 0.0% 1606.0% 131,685 0.2% -0.5% 613 0.3% -0.5% 610 0.3%
Foreign debt securities -100.0% 0 0.0% 0% 0 0.0% 0.0% 0 0.0% 0% 0 0.0%
All other securities 1.1% 8,804,028 14.2% 3.0% 9,064,146 12.3% #N/A 2,104 1.1% -2.2% 2,057 1.0%
Interest bearing bank balances 16.4% 259,318 0.4% 51.8% 393,713 0.5% #N/A 4,428 2.3% -57.5% 1,881 0.9%
Fed funds sold & resales -54.6% 1,106,733 1.8% 56.2% 1,728,372 2.3% 175.0% 7,000 3.6% -21.4% 5,500 2.6%
Trading account assets -9.1% 935,042 1.5% 78.3% 1,667,330 2.3% 0.0% 0 0.0% 0.0% 0 0.0%
Total Investments 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%
Total Earning Assets -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%
Nonint Cash & Due from banks -6.9% 2,926,330 4.7% 8.5% 3,174,493 4.3% -16.6% 13,083 6.8% -10.7% 11,682 5.6%
Premises, fixed assets & capital leases
24.4% 1,039,603 1.7% 2.5% 1,066,028 1.4% 12.2% 5,642 2.9% 2.2% 5,768 2.7%
Other real estate owned 21.8% 14,208 0.0% 0.7% 14,301 0.0% -84.3% 325 0.2% -100.0% 0 0.0%
Investment in unconsolidated subs. 252.4% 17,386 0.0% -12.4% 15,223 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Acceptances and other assets 51.8% 7,754,149 12.5% -6.2% 7,272,017 9.9% 259.8% 7,761 4.0% 13.2% 8,783 4.2%
Total Assets 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%

Average Assets During Quarter 6.8% 62,719,462 101.1% 17.0% 73,391,052 99.4% 17.5% 191,480 99.4% 9.4% 209,525 99.7%
 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 reserves)
 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
 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
 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

 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
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.
Bank investments and FASB 115

amortized cost, market value (fair value)

http://books.google.com.vn/books?id=c3f0AegbDx4C&pg=P
A221&lpg=PA221&dq=amortized+cost&source=bl&ots=
PYzqn9tqrJ&sig=0qSsODiLgsl3_fDOZJWo91L4Zu8&hl
=vi&ei=RfKHS6PBKNegkQWUgrmhDw&sa=X&oi=book
_result&ct=result&resnum=7&ved=0CCUQ6AEwBg#v=
onepage&q=amortized%20cost&f=false
 5-16

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
 5-17

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
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.
 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 reserves
◼ Remaining ALL
◼ Determined by management but influenced by
taxes and government regulation
◼ Loans to lesser developed countries require
allocated transfer reserves
ALL : 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 Circular 02/2013/TT-NHNN dated January 21, 2013
 Provisions for loan losses

Recoveries

Provisions for loan losses

Reserve for Loan Losses Charge offs

 Average assets, capital and loan loss data: PNC and Community NB
PNC BANK, NATIONAL ASSOCIATION COMMUNITY 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

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

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% 0 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%
 5-23

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
◼ Money market deposit accounts (MMDAs)
◼ Pay market rates, but a customer is limited to no
more than six checks or automatic transfers each
month
◼ Savings and time deposits represent 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 located
outside the U.S.
 5-26

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
 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 one year.*
*The UBPR (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
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 1,000 Total % Cha 1,000 Total

LIABILITIES
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 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%
Money market deposit accounts 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%
Other 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%
Core Deposits 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%
Time deposits of $100M or more -17.6% 1,775,943 2.9% 80.5% 3,205,331 4.3% 4.9% 13,572 7.0% 8.4% 14,714 7.0%
Deposits held in foreign offices 71.5% 2,371,548 3.8% 26.3% 2,994,623 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Total deposits 3.2% 45,548,444 73.4% 16.1% 52,866,018 71.6% 19.3% 177,289 92.0% 9.1% 193,418 92.0%
Fed funds purchased & resale 25.2% 499,232 0.8% 221.8% 1,606,647 2.2% 0.0% 1,000 0.5% 0.0% 1,000 0.5%
FHLB borrowings < 1 Yr 898.2% 1,000,000 1.6% -100.0% 0 0.0% 0.0% 0 0.0% 0.0% 0 0.0%
Other borrowings inc mat < 1 yr 99.4% 2,264,921 3.7% 34.5% 3,046,632 4.1% 0.0% 0 0.0% 0.0% 0 0.0%
Memo: S.T. non core funding 73.5% 7,111,124 11.5% 25.7% 8,936,809 12.1% 0.1% 7,901 4.1% 28.7% 10,169 4.8%
Memo: S.T. Volatile liabilities 36.2% 6,911,644 11.1% 57.0% 10,853,233 14.7% 4.5% 14,572 7.6% 7.8% 15,714 7.5%
FHLB borrowings > 1 Yr -90.0% 115,406 0.2% -23.3% 88,508 0.1% 0.0% 0 0.0% 0.0% 0 0.0%
Other borrowings inc mat > 1 yr -2.9% 1,765,851 2.8% 105.2% 3,624,223 4.9% 0.0% 0 0.0% 0.0% 0 0.0%
Acceptances & other liabilities -0.1% 3,864,388 6.2% 18.7% 4,585,994 6.2% -11.0% 395 0.2% 31.6% 520 0.2%
Total Liabilities before Sub. Notes 4.6% 55,058,242 88.8% 19.5% 65,818,022 89.2% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
Sub. Notes & Debentures 16.2% 1,340,133 2.2% 41.4% 1,895,482 2.6% 0.0% 0 0.0% 0.0% 0 0.0%
Total Liabilities 4.9% 56,398,375 90.9% 20.1% 67,713,504 91.7% 19.1% 178,684 92.7% 9.1% 194,938 92.8%
All common and preferred capital -4.1% 5,622,521 9.1% 8.4% 6,095,661 8.3% 12.0% 14,043 7.3% 8.2% 15,194 7.2%
Total Liabilities & Capital 4.0% 62,020,896 100.0% 19.0% 73,809,165 100.0% 18.6% 192,727 100.0% 9.0% 210,132 100.0%
Memoranda:
Officer, Shareholder Loans (#) 0.0% 2 0.0% 50.0% 3 0.0% -50.0% 1 0.0% 0.0% 1 0.0%
Officer, Shareholder Loans ($) -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% 46,258 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)
 5-30

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

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 presently does not own
◼ Futures 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 234-year-old Barings
Bank in 1995 by Nicholas Leeson
http://www.time.com/time/2007/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
 5-34

Report of Income for BB&T Corporation

 5-35

Net interest income =

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

Noninterest income Noninterest expenses

▪ Fees earned from ▪ Wages, salaries, and

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

 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.
 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
Noninterest expense
…composed primarily of:

◼ Personnel expense:
◼ Salaries and fringe benefits paid to bank
employees
◼ Occupancy expense :
◼ Rent and depreciation on equipment and
premises, and
◼ Other operating expenses:
◼ Utilities
◼ Deposit insurance premiums
 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.
 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
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
of a bank?
5-45
 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/articl
es/specpurpentity.htm)
◼ Window dressing
◼ Eliminate Fed borrowing prior to financial statement
reporting date
◼ Increase asset size prior to year-end
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 agency
that collects taxes and enforces the internal revenue laws.
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
◼ This type of transaction is not part of the
bank’s daily activities and typically cannot be
repeated; thus it overstates earnings
 FINANCIAL
STATEMENTS OF BANKS

Chapter 2

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