Financial Statement

Analysis for Finance

Companies
 Finance Companies
► Typesof Non-bank
Banks (NBB). Finance
Only Grant
Company
►Sort of banks, but not Loans
really

Take Deposits
Bank NBB Do only one.
Grant Loans
 Types of Finance
Companies P15M
According to who the customers are:
P10M
A. Consumer Finance Companies
1. Auto-Loans: Finance a car or vehicle purchase.
2. Home Mortgages: The collateral is a real estate
property
3. Consumer Durables: Appliances and Furniture
 Types of Finance
Companies
According to who the customers are:
B. Business Finance Companies
1. Floor-plan Inventory: Finance an inventory for a
business with the “floor” of inventory as the
collateral.
2. Leasing: (e.g. trucking)
3. Accounts Receivable Financing: (e.g. Pledging,
Factoring).
 Types of Finance
Companies
►According to who the owners are:
A. Captive Sales Finance Companies: Owned by the auto-
dealer companies (usually cars).
B. Sales Finance Company: to cater not only one auto-
dealers.
C. Bank Subsidiary
D. Independent Finance Company
 Financing Finance
Companies
Short-term Loans
Liabilities Payable
Assets Long-term
Commercial
Equity Papers
Bonds
Small Payable
Regulation of Financing Companies

► SEC
► BSP
► Minimum Capital Adequacy Ratio (CAR)
Basel II - 8%
Basel III – 10.5%
Products of Financial Services Industry in
the US -1950 vs 2007
Examples of FI with quasi-banking functions
RISKS OF FINANCIAL
INTERMEDIATION
Financial Intermediation (FI) Management

MAIN OBJECTIVE:
▪ TO INCREASE THE FI’S RETURNS FOR ITS OWNERS

HOWEVER,
▪ AT THE COST OF INCREASED RISK
Risks Faced by Financial Intermediaries
 INTEREST RATE RISK
 MARKET RISK
 CREDIT RISK
 OFF-BALANCE SHEET RISK
 FOREIGN EXCHANGE RISK
 COUNTRY OR SOVEREIGN RISK
 TECHNOLOGY RISK
 OPERATIONAL RISK
 LIQUIDITY RISK
 INSOLVENCY RISK
 INTEREST RATE RISK
 The risk incurred by an FI when the maturities of the
assets and liabilities are mismatched.

 Example:
An FI issues PHP 50 Million of liabilities of one-year
maturity to finance the purchase of PHP 50 Million of assets
with two-year maturity. The FI is viewed as short funded
because the maturity of its liability is less than the maturity
of its assets.
 MARKET RISK
 The risk incurred in the trading of assets and liabilities
due to the changes in interest rates, exchange rates and
other asset prices.

 Market risk arises when FIs actively trade assets and

liabilities rather than hold them for longer term
investment, funding or hedging purposes.
 CREDIT RISK
 The risk that promised cash flows from loans and
securities held by FIs may not be paid in full.

 FIs that make loans or buy bonds with long maturities are
more exposed than are FIs that make loans or buy bonds
with short maturities.

 Example: banks are more exposed to credit risk than are

money market mutual funds and property–casualty
insurance companies
 OFF-BALANCE-SHEET RISK
 The risk incurred by an FI due to activities related to contingent
assets and liabilities.
 An off-balance-sheet activity, does not appear on an FI’s current
balance sheet since it does not involve holding a current primary
claim (asset) or the issuance of a current secondary claim (liability).
 The off-balance-sheet activities affect the future shape of an FI’s
balance sheet in that they involve the creation of contingent assets
and liabilities that give rise to their potential (future) placement on
the balance sheet.
 Accountants place them “below the bottom line” of an FI’s asset and
liability balance sheet.
 Example of an off-balance-sheet activity is the issuance of standby
letter of credit guarantees by insurance companies and banks to back
the issuance of municipal bonds.
 FOREIGN EXCHANGE RISK
 The risk that exchange rate changes can affect the value
of an FI’s assets and liabilities denominated in foreign
currencies.
 Example: PHP to USD; USD to British Pound
 COUNTRY OR SOVEREIGN RISK
 The risk that repayments from foreign borrowers may be interrupted
because of interference from foreign governments.
 Examples: U.S., European, and Japanese banks had enhanced sovereign
risk exposures to countries such as Argentina, Russia, Thailand, South
Korea, Malaysia, and Indonesia. Financial support given to these countries
by the International Monetary Fund (IMF), the World Bank, and the U.S.,
Japanese, and European governments enabled the banks to avoid the full
extent of the losses that were possible. Nevertheless, Indonesia had to
declare a moratorium on some of its debt repayments, while Russia
defaulted on payments on its short-term government bonds. In 1999,
some banks agreed to settle their claims with the Russian government,
receiving less than five cents for every dollar owed them. In 2001, the
government of Argentina, which had pegged its peso to the dollar on a
one-to-one basis since the early 1990s, had to default on its government
debt largely because of an overvalued peso and the adverse effect this
had on its exports and foreign currency earnings. In December 2001,
Argentina ended up defaulting on $130 billion in government-issued debt
and, in 2002, passed legislation that led to defaults on $30 billion of
corporate debt owed to foreign creditors. Argentina’s economic problems
continued into 2003; in September 2003 it defaulted on a $3 billion loan
repayment to the IMF.
 TECHNOLOGY RISK
 The risk incurred by an FI when technological investments do
not produce the cost savings anticipated.
 Economies of scale refer to an FI’s ability to lower its average
costs of operations by expanding its output of financial
services.
 Economies of scope refer to an FI’s ability to generate cost
synergies by producing more than one output with the same
inputs.
 Example: an FI could use the same information on the quality of
customers stored in its computers to expand the sale of both
loan products and insurance products. That is, the same
information (e.g., age, job, size of family, income) can identify
both potential loan and life insurance customers. Indeed, the
attempt to better exploit such economies of scope lies behind
megamergers such as that of Citicorp with Travelers to create
Citigroup, an FI that services over 100 million customers in
areas such as banking, securities, and insurance.
 OPERATIONAL RISK
 The risk that existing technology or support systems may malfunction or break
down.
 Examples:
A. Failure of a back-office system occurred in September 2001 when Citibank’s (a
subsidiary of Citigroup) ATM system crashed for an extended period of time. Citibank’s
2,000 nationwide ATMs, its debit card system, and its online banking functions went
down for almost two business days.
B. In February 2005 Bank of America announced that it had lost computer backup
tapes containing personal information such as names and Social Security numbers on
about 1.2 million federal government employee charge cards as the tapes were being
transported to a data-storage facility for safe keeping. Bank of America could not rule
out the possibility of unauthorized purchases using lost data, but it said the account
numbers, addresses, and other tape contents were not easily accessible without
highly sophisticated equipment and technological expertise. Even though such
computer breakdowns are rare, their occurrence can cause major dislocations in the
FIs involved and potentially disrupt the financial system in general.
C. Several highly publicized securities violations by employees of major
investment banks resulted in criminal cases brought against securities law violators by
state and federal prosecutors.
 LIQUIDITY RISK

 The risk that a sudden surge in liability withdrawals may

leave an FI in a position of having to liquidate assets in a
very short period of time and at low prices.
 INSOLVENCY RISK
 The risk that an FI may not have enough capital to offset a
sudden decline in the value of its assets relative to its
liabilities.
 Insolvency risk is a consequence or outcome of one or
more of the risks described above: interest rate, market,
credit, off-balance-sheet, technology, foreign exchange,
sovereign, and liquidity risks. Technically, insolvency
occurs when the capital or equity resources of an FI’s
owners are driven to, or near to, zero because of losses
incurred as the result of one or more of the risks
described above.
 THANK YOU!

 FROM THE TEXT BOOK: FINANCIAL INSTITUTIONS MANAGEMENT - A RISK

MANAGEMENT APPROACH BY ANTHONY SAUNDERS AND MARCIA MILLON
CORNETT
FINFSAF
SUMMARY OF GROUP PRESENTATIONS

TOPICS NATURE OF BUSINESS OFFENSES PERSONS INVOLVED IMPACT

MADOFF ATTRACTED INVESTORS BY PROMISING
THEM EXTRAORDINARILY HIGH RETURNS ON THEIR MADOFF ADMITTED TO BE THE MASTERMIND OF THE LARGEST KNOWN
INVESTMENTS. BUT, WHEN INVESTORS HANDED
PONZI SCHEME IN HISTORY INVOLVING AN ESTIMATED $65 BILLION.
OVER THE MONEY, MADOFF JUST DEPOSITED IT
BROKER DEALER FOR INVESTORS WHO INVESTED IN THIS SCHEME LOST THEIR MONEY. A
1 BERNIE MADOFF INTO HIS PERSONAL ACCOUNT. HE PAID "RETURNS" BERNIE MADOFF
SECURITY BROKERAGE AND TO EARLIER INVESTORS USING THE MONEY
PONZI SCHEME IS A FORM OF FRAUD THAT LURES INVESTORS AND PAYS
FINANCIAL ADVISORY OBTAINED FROM LATER INVESTORS. MADOFF'S PROFITS TO EARLIER INVESTORS WITH FUNDS FROM MORE RECENT
SERVICES TO BANKS AND PROFIT SHOWED IN THE FINANCIAL REPORTS INVESTORS. THIS IS THE SAME AS 'PYRAMID SCAM' IN THE PHILIPPINES.
FINANCIAL INSTITUTIONS WERE ALL FABRICATIONS.

THE FORMER CEO ADMITTED HIS ROLE IN THE CASE. THE TOTAL
FINANCE AND INSURANCE SHAM REINSURANCE TRANSACTIONS; BAILOUT WAS USD 182 BILLION.
2 AIG HANK GREENBERG (CEO) & HOWARD SMITH (CFO)
COMPANY INVESTED IN SUB PRIME MORTGAGES THE U.S. GOVERNMENT PROVIDED AIG WITH A $85 MILLION BAILOUT
AND LESSER REGULATION WAS APPLIED TO THE BUSINESS

LEHMAN'S BANKRUPTCY SENT FINANCIAL MARKET REELING. THEIR

FALSE ACCOUNTING PRACTICES; INVESTED IN FAILURE STRESSED THE GLOBAL INTERBANK AND FOREIGN EXCHANGE
3 LEHMAN BROTHERS INVESTMENT BANKING RICHARD S. FULD, JR. - CEO
SUB PRIME MORTGAGES MARKETS BECAUSE IT LEDTO A RUN ON MONEY MARKET FUNDS, THE
LARGEST SUPPLIERS OF DOLLAR FUNDING TO NON-US BANKS.

BERNARD EBBER - CEO AFTER THE MERGER

WRONG BOOKING OF ACCOUNTING CONGRESS PASSED THE SARBANES-OXLEY ACT IN JULY 2002 THAT HELPS
TECHNOLOGY - WIRELESS, SCOTT SULLIVAN - WORLDCOM CHIEF FINANCIAL OFFICER
4 WORLDCOM TRANSACTIONS -OVERSTATED REVENUES; STRENGTHEN THE DISCLOSURE REQUIREMENTS AND PUNISHMENT FOR
AND FIBER NETWORK DAVID MYERS - CORPORATE CONTROLLER
INCORRECT RECOGNITION OF EXPENSE FRAUDULENT ACCOUNTING

AVOIDING DEPRECIATION EXPENSES, FAILED

TO RECORD LANDFILL EXPENSES, FALSE DEAN BUNTROCK - BOD CHAIRMAN AND CEO
PROFITS MOVING INTO RETAINED EARNINGS, PHILLIP ROONEY - PRESIDENT, COO, DIRECTOR THE COMPANY PAID $26.8 MILLION TO SETTLE THE LAWSUIT BY THE
SETTING HIGH EARNINGS TARGETS AND JAMES KOENIG - EXEC. VP AND CFO SECURITIES AND EXCHANGE COMMISSION. ALSO, THE SIX OFFICERS
ENVIRONMENTAL SERVICES DIRECTED ACCOUNTING CHANGES, FAILED TO
5 WASTE MANAGEMENT THOMAS HAU - VP, CORPORATE CONTROLLER, CAO WERE BARRED FROM BEING AN OFFICER OR DIRECTOR IN ANY
COMPANY RECORD THE WRITE-OFFS OF THE COMPANY, BRUCE TOBECKSEN - VP OF FINANCE COMPANY AND WAS CHARGED TO JOINTLY PAY APPROXIMATELY $30.8
MISLEADING THE COMPANY'S AUDIT HERBERT GETZ - SENIOR VP, GENERAL COUNSEL, MILLION.
COMMITTEE AND INTERNAL AUDITORS, SECRETARY
DESTROYING EVIDENCE, WITHHOLDING
INFORMATION FROM OUTSIDE AUDITORS,
RICHARD SCRUSHY - CEO WORKER LAYOFFS, SHUTTING DOWN OF MUSEUMS & BUSINESS,
HEALTHCARE AND MISREPRESENTED THEIR FINANCIAL POSITION
6 HEALTH SOUTH WESTON SMITH - CFO FULFILLING ALL PAYMENTS TO AVOID BANKRUPTCY, HEALTHCARE
REHABILITATION COMPANY DID NOT DISLCOSE NEGATIVE TRENDS
SENIOR OFFICIALS DISRUPTION
SECURITY SOLUTIONS AND
7 TYCO QUESTIONABLE FINANCIAL TRANSACTIONS CEO AND CFO PERSONS INVOLVED WERE FINED AND IMPRISONED
FIRE PROTECTION
FINFSAF
SUMMARY OF GROUP PRESENTATIONS

TOPICS NATURE OF BUSINESS OFFENSES PERSONS INVOLVED IMPACT

DAVID W. GLENN (PRESIDENT AND COO AND VICE
THEY PAID USD 125 MILLION FOR THEIR FRAUDULENT ACTIONS; LOSS
SECONDARY MORTGAGE ACCOUNTING FRAUD & MANAGEMENT CHAIRMAN OF THE BOARD)), VAUGHN A. CLARKE (CFO),
8 FREDDIE MAC OF TRUST AND CONFIDENCE; FINANCIAL LOSSES: RESTRICTED TRADING
MARKET MISCONDUCT AND FORMER SENIOR VICE PRESIDENTS ROBERT C DEAN
AND DIVERSIFICATION; CHANGE OF EMPLOYEE BENEFITS
AND NAZIR DOSSAN
NEW LEGISLATION AND RULES AIMED AT IMPROVING FINANCIAL
REPORTING ACCURACY FOR PUBLICLY LISTED CORPORATIONS, THE
KENNETH LAY - FOUNDER, CEO SARBANES-OXLEY ACT (2002).
JEFFREY SKILLING - PRESIDENT, COO WHEN THE COMPANY COLLAPSED, AN ESTIMATE OF 29,000 PEOPLE
NATURAL GAS AND ENERGY IRREGULAR ACCOUNTING PRACTICES - ANDREW FASTOW - CFO LOST THEIR JOBS, 20,000 LOST THEIR SAVINGS AND INSURANCE AND 1
9 ENRON
COMPANY OFF-THE-BOOK ACCOUNTING PRACTICES DAVID DUNCAN - AUDITOR EMPLOYEE COMMITTED SUICIDE BECAUSE OF THE ISSUE WHILE THE
ARTHUR ANDERSEN LLP - ACCOUNTING FIRM EXECUTIVES GOT IMPRISONED BUT ALSO KEPT A LOT OF MONEY. ONE
OF THE FORMER EXECUTIVES, JEFFREY SKILLING, THE CEO BEFORE THE
COLLAPSE HAPPENED, WAS IMPRISONED FOR MORE THAN A DECADE
AND WAS RELEASED LAST 2019.

RECOMMENDATIONS

CREATE AN INTERNAL AUDIT GROUP THAT DIRECTLY REPORTS TO THE AUDIT COMMITTEE OF THE COMPANY'S
BOARD OF DIRECTORS. THE AUDITORS SHOULD HAVE A STRONG SENSE OF INTEGRITY, COMPETENCE, AND
1
PROFESSIONALISM. THIS IS ON TOP OF THE EXTERNAL AUDITORS HIRED PRIMARILY TO EXAMINE THE
COMPANY'S FINANCIAL STATEMENTS REGULATED BY THE SEC AND BIR (PHILIPPINE SETTING).

SET POLICIES AND PROCEDURES TO STRENGTHEN INTERNAL CONTROL INCLUDING THE POLICY OF
2 TERMINATING AN EMPLOYEE COMMITTING ANY IRREGULARITIES THAT WILL HAVE A NEGATIVE FINANCIAL
IMPACT TO THE COMPANY.
3 STRENGTHEN ETHICAL VALUES.
4 PROPER ORGANIZATIONAL STRUCTURE.

PROMOTE TRASPARENCY, RESPONSIBILITY AND ACCOUNTABILITY. PUT IN PLACE CHECK AND BALANCE IN ALL
5
THE DEPARTMENTS.

6 CONDUCT LIFESTYLE CHECK, IF NEEDED.

FOR FINANCIAL INSTITUTIONS, APPLY THE SARBANES-OXLEY ACT OF 2002 AS A DISCLOSURE REQUIREMENT TO
7
CATCH FRAUDULENT ACCOUNTING PRACTICES.