bank management
DESCRIPTION
Bank ManagementTRANSCRIPT
Bank Balance Sheets and Income Statements
Unit Agenda
• FDIC Website: UBPR, SDI, CTR• Overview of Bank Balance Sheets• Overview of The Income Statement
1. Components of Profits2. Profitability Analysis
Unit Objectives
• Students will be able to obtain information on bank profitability from publicly available records.
• Students will be able to calculate measures of bank profitability and explain the significance.
• Students will be able to use 6 steps of profitability analysis for trend and peer comparisons.
FDIC Data
• In USA, bank deposits are insured by government owned Federal Deposit Insurance Corporation are required to submit quarterly data on income and balance sheets to regulator which is available on-line in easy to use form.
• UBPR – Comprehensive set of quarterly data for every bank in the US collected by Federal Financial Instituting Examination Council. Link.
Additional Data
Additional macro or industry level data from FDIC & Fed linkable from the site.
• Call and Thrift Reports Detailed Balance Sheet and Income Statement for each bank. Link
• Statistics on Depositary Institutions Create reports with customized peer groups. Link
Analyzing Bank Performance in HK
• Data less easily available in consistent comparable form.
• Main source of bank data will be bank annual reports. Most information is available in annual and interim reports on the web.
• Less useful, because the data is not as consistent across banks and not reported as frequently.
Analysis
• Peer Analysis - Compare with others in same business situation
• Trend Analysis – Compare performance with previous periods.
Learn About Bank Balance Sheets at HSBC Subsidiary
HSBC National Association, USA
Balance Sheets
Assets
1. Loans
2. Investment Securities
3.Noninterest Cash & Due from Banks
4.Other
Liabilities
1. Transactions Accounts
2.Savings and Time Deposits
3.Other Borrowings
Equity
Peer Comparison: AssetsHSBC National Association 8743
3 Total assets 166,631,767 11,757,683,470A. Loans 89,014,289 53.4% 7,091,356,071 60.3%
8 Net loans & leases 89,014,289 7,091,356,0719 Loan loss allowance 883,837 77,947,959
B. Investments 65,056,873 39.0% 3,323,577,178 28.3%5 Interest-bearing balances 2,599,612 156,842,3096 Securities 22,529,121 1,991,937,1017 Federal funds sold & reverse repos 14,677,257 578,081,565
10 Trading account assets 25,250,883 596,716,203C. Non-Interest Cash and Due from Banks 3,672,570 2.2% 586,967,795 5.0%
4 Cash and due from depository institutions 6,272,182 430,125,4865 Interest-bearing balances 2,599,612 156,842,309
D. Other 8,888,035 5.3% 1,069,467,043 9.1%11 Bank premises and fixed assets 525,791 109,358,46712 Other real estate owned 46,294 6,684,37813 Goodwill and other intangibles 2,597,390 387,892,08214 All other assets 5,718,560 565,532,11615 Life insurance assets 200,894 102,375,796
Source: SDI Cert. 57890
Types of Bank AssetsShow Website on Screen
• Cash and Funds Due: – Vault Cash– Deposits at Central Bank – Cash items in process of Collection
Types of Bank Assets cont.• Investments
– Deposits at other banks– Lending of central bank reserves (to other banks)– Securities:
Maturity Accounting1. Short-term
(<1 year)
2. Long-term (>1 year)
1. Held-to-Maturity (valued at cost)2. Trading Account Securities
(marked-to-market)3. Available-for-sale (marked-to-
market)
Composition of Securities
HSBC USA
Available for sale (fair
market value) 41%
Trading account assets
53%
Held to maturity
(book value) 6%
All Institutions
Available for sale (fair
market value) 70%
Trading account assets
23%
Held to maturity (book
value) 7%
Types of Bank Assets, cont.
• Net Loans and Leases, Loans to customers less the allowances for loan losses.
• Loan loss accounts are contra-assets, deductions from value of loans which are chosen subjectively (subject to regulatory approval).
HSBC AllUSA Institutions
All real estate loans 55.50% 60.44%Farm loans 0.06% 0.43%Commercial and industrial loans 18.25% 16.41%Loans to individuals 21.91% 14.59%Total other loans and leases * 4.28% 8.13%
Liabilities
HSBC USA Federally Chartered Institutions
Total liabilities 154,571,824 7,399,096,294Transaction accounts 6,429,631 4.2% 443,810,074 6.0%Nontransaction accounts 67,942,235 44.0% 3,655,825,585 49.4%Other Liabilities 80,199,958 51.9% 3,299,514,125 44.6%
Types of Liabilities• Deposits: Main source of funding for commercial
banks. Transactions Non Transactions
Non Interest Paying
Demand Deposits
Small Savings Deposits
Interest Paying
MMDANOW
SavingsTime Deposits < 100KTime Deposits > 100K
OtherVolatile
Fed Funds, Brokered Deposits, Foreign Office Deposits, Short-term Borrowings
Volatile Liabilities in Red
Types of Liabilities, cont.
• Fed Funds Purchased: Short-term loans from one bank to another with securities as collateral.
• Trading liabilities: Obligations of banks’ securities dealers.
• Other Borrowed Money: Short-term borrowings and commercial paper.
• Subordinated Debt: Debt w/ maturity > 1 yr. and junior to deposits.
• Foreign Office Deposits: Deposits at Foreign Subsidiaries.
Income Statement
NII
Net Interest Income: Interest Income-Interest Expense
- Burden Non-interest Income-Non-interest Expense
- PLL Provision for Loan Losses and Leases
+ SG Securities Gains
- T Applicable Taxes
+ XG Extraordinary Gain
= NI Net Income
Statistics For Depository Institutions
HSBC National Association (Year-to-date) Income and Expense 9/30/2007 9/30/2006Total interest income 6,674,815 5,824,761Total interest expense 4,020,472 3,398,247
NII Net interest income 2,654,343 2,426,514PII Provision for loan and lease losses 873,134 585,895Total noninterest income 1,629,423 1,643,787Fiduciary activities 72,706 65,232Service charges on deposit accounts 166,128 159,063Trading account gains & fees 439,937 421,671Additional noninterest income 950,652 997,821Total noninterest expense 2,484,787 2,282,546Salaries and employee benefits 958,909 888,797Premises and equipment expense 176,689 179,919Additional noninterest expense 1,349,189 1,213,830
BURDEN 855,364 638,759Pre-tax net operating income 925,845 1,201,860
SG Securities gains (losses) 31,465 16,965
T Applicable income taxes 292,169 414,089Income before extraordinary items 665,141 804,736
XG Extraordinary gains - net 0 -3,814Net income 665,141 800,922
Net Interest:Key Source of Profits
• Main business of commercial banks is taking deposits at interest and making loans or buying interest paying assets.
• Net Interest Income (NII) =Interest Revenue – Interest Expenses
Foreign office loans 82,145Lease financing receivables 4,264Balances due from depository institutions 116,643Securities 870,114Trading accounts 275,011Federal funds sold 190,678Other interest income 32,005Total 6,098,094
HSBC USA N.A., 12/31/2005
Statistics For Depository Institutions
Sources of Interest IncomeHSBC USA N.A., 12/31/2005 CTR
Domestic Office LoansLoans secured by real estate 2,861,663 63.21%Loans to finance agricultural production and other loans to farmers 2,050 0.05%Commercial and industrial loans 530,230 11.71%(1) Credit cards 812,798 17.95%(2) Other individual loans 236,419 5.22%Loans to foreign governments and official institutions. 168 0.00%All other loans in domestic offices 83,906 1.85%
4,527,234 100.00%SecuritiesU.S. Treasury securities and U.S. Government agency obligations 56,485 6.49%Mortgage-backed securities 682,616 78.45%All other securities (includes state and municipal) 131,013 15.06%
870,114 100.00%
U.S. Banks heavily dependent on income from property sector like Hong Kong!
Statistics For Depository Institutions
Sources of Interest ExpenseHSBC USA N.A., 12/31/05 SDI
& CTRDomestic office deposits 1,106,807Foreign office deposits 733,802Federal funds purchased 52,635Trading liabilities and other borrowed money 768,982Subordinated notes and debentures 217,237
Transaction accounts (NOW accounts, ATS accounts, etc.) 685(1) Savings deposits (includes MMDAs) 321,392(2) Time deposits of $100,000 or more 578,695(3) Time deposits of less than $100,000 206,035
Other sources of profits
• Banks face other expenses (salaries, rent, etc.) and have other sources of income such as fees and services. Banks have an increasing role in providing services to financial markets. In HK, banks have many financial businesses including credit cards, insurance, etc.
• Burden = Noninterest Expenses – Noninterest Revenues
Sources of Non-Interest IncomeHSBC USA N.A., 12/31/2005 SDI
Fiduciary activities 87,341Service charges on deposit accounts 208,434Trading account gains & fees 364,824 Investment banking, advisory, brokerage, and underwriting fees and commissions 10,983Venture capital revenue 0Net servicing fees 48,015Net securitization income 113,718Insurance commission fees and income 32,761Net gains(losses) on sales of loans 10,120Net gains (losses) on sales of other real estate owned 2,056Net gains (losses) on sales of other assets (excluding securities) 77,956Other 709,765
US$, 000, CTR
Sources of Non-Interest ExpenseHSBC USA N.A., 12/31/05 SDI
Salaries and employee benefits 956,378Premises and equipment expense 237,058 Amortization expense and impairment losses for other intangible losses 4,390Goodwill impairment losses 0Other noninterest expense 1,435,531
CTR
Loan Provisions• When loans are not repaid, these losses occur
they will have a negative impact on profits. • To prevent unexpected losses from leading to
fluctuations in profits, banks create a loan reserve account.
• Loan reserves are a contra-asset account, i.e. an account of deductions from stock of loans.
Net Loans = Gross Loans – Loan Reserves • When loans are not repaid, their amount is
deducted from Gross Loans & Loan Reserves• When bank makes Provisions for Loan Losses
this amount is added to Loan Reserves & deducted from profits.
Etc.
• Securities Gains: Changes in Mark-to-Market value of financial assets.
• Extraordinary Items: One time gains and losses on asset sales.
• Taxes
Evaluating Bank Performance
ROE Analysis
Measures of Performance
• Benchmark measure of a banks profitability is the return on equity which is profits per unit of dollars invested by the banks owners. i.e. dollars of income divided by equity in the bank.
• Corresponds with a rate of return on investment.
• Items on the Income Statement are generated over a period of time while items on the Balance sheet are at a point in time.
Averaging Stock Variables
• Example: Consider equity value of HSBC USA, N.A., at ends of 2004 and 2005 compared with income earned over 2005.
NI[2005] Equity NI/Equity1,016,372 Dec. 31, 2004 11,372,560 8.9%
Jun. 30, 2004 12,142,210 8.4%
Most appropriate to average balance sheet variables over the year.
NIReturn on Equity ROEAverage Equity
Averages
Average of available balance sheets. • Quarterly (and semi-annual) income
statements report on a year-to-date basis. [e.g. income on 9/30 is the income earned from January through September].
• To get appropriate denominator, start with end of previous year and take average of end of period balance sheets over the year. Annualize.
HSBC USA Return on Equity
Average NI/ AnnualizedEquity Assets Equity AvgeEq ROE
Dec. 31, 2005 11,888,099 1,016,372 11,836,182 0.08587 8.59%Sep. 30, 2005 12,375,281 792,829 11,823,202 0.067057 8.94%Jun. 30, 2005 12,142,210 525,347 11,639,176 0.045136 9.03%Mar. 31, 2005 11,402,758 319,197 11,387,659 0.02803 11.21%Dec. 31, 2004 11,372,560
Year to Date Averages, Check against UBPR
Last YearHSBC National Assoc.
Qtr by Qtr Averages SDIHSBC National Association
12/31/2006 9/30/2006 6/30/2006 3/31/2006 12/31/2005Assets 165,673,017 166,631,767 168,899,000 158,753,889 150,679,481Equity 12,257,932 12,059,943 12,259,680 12,102,159 11,888,099
Income 1,011,140 ROE 0.08347Averrage Assets 162,127,431 ROA 0.00624Average Equity 12,113,563 EM 13.38396
PERCENT OF AVERAGE TOTAL EQUITY: BANK PG 1 PCT NET INCOME 8.35 12.89 22 DIVIDENDS 7.06 6.26 58 RETAINED EARNINGS 1.29 5.65 23
Compare Q-by-Q ROE with UBPR
Quarterly Averages
• For some balance sheet variables, such as assets, banking firms construct day-by-day or week-by-week averages and report these on a quarterly basis.
• Averages (across quarters) of these daily/weekly averages are used to most accurately calculate yields for UBPR.
Determinants of ROE
• The first step in analyzing profits is to decompose returns into the profitability of assets and the leverage of the bank.
ROE ROA EM
NIROAaverage Total Assets
average Total AssetsEMaverage Total Equity
LeverageProfitability of Banks Assets
Equity Multiplier• Banks’ owners earn profits on the spread
between interest on lending and the interest on deposits.
• When the leverage (EM) is high, banks are accepting a lot of deposits and can earn high income levels.
• A high multiplier multiplies profits when profits are positive. But in periods with negative profits, negative profits may also be multiplied.
• A high EM is a risk factor since it reduces the amount of assets that can go bad without the bank itself going bankrupt.
Capitalization is a key pillar of bank regulation
Dupont Analysis
ROA
Expense RatioAsset Utilization
Income Management Cost Management
TaxROA AU ERaverage Total Assets
Dupont Analysis (Bank Version)• ROA for all types of firms can be decomposed
into revenue and cost management. • AU = Asset Utilization (Revenue Management)
• ER = Expense Ratio (Cost Management)
RevenuesAUaverage Total Assets
Total Operating ExpenseERaverage Total Assets
II. Earnings and Profitability Analysis
• The Dupont Analysis can decompose owner’s returns into cost management and revenue management.
• Profitability Analysis decomposes cost management and revenue management into narrower categories of cost and revenue to evaluate the source of profits.
Asset Utilization
Asset Utilization (UA)
Non Interest Revenue/Assets
Interest Revenue/Assets
1. Rate2. Composition3. Volume Effects
+
=
SecuritiesGains
Non Interest Income is growing as a share of operating income
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
%
1991 1996 2001
Non Interest Income as % of Income
USA Japan
Source: Hoshi and Kashyap, 2002
Determinants of Net Interest Income
Interest Earning assets as a share of assets 1. Volume Effects
2. Rate Effects: Level of interest earned on assets of a given type.
3. Composition/Mix Effects: Types of interest earning assets.
Earning AssetsTotal Assets
Yield AnalysisBanks with Assets > US$50 billion
Source: UBPR Custom Peer Group Reports
2004 2003 2002TOTAL LOANS & LEASES (TE) 5.74 5.81 6.52 LOANS IN DOMESTIC OFFICES 5.72 5.76 6.51 REAL ESTATE 4.61 4.51 5.31 COMMERCIAL & INDUSTRIAL 5.36 5.55 5.69 INDIVIDUAL 5.99 6.02 7.41 CREDIT CARD 6.28 4.11 4.91 AGRICULTURAL 3.63 3.19 3.56 LOANS IN FOREIGN OFFICES 3.09 3.23 2.53TOTAL INVESTMENT SECURITIES(TE) 3.94 3.96 5.09INTEREST-BEARING BANK BALANCES 2.12 1.85 2.48FEDERAL FUNDS SOLD & RESALES 1.53 1.55 1.99
Expense Ratio and Cost ManagementER
Interest ExpensesaTA
NonInterest ExpensesaTA
PLLaTA
1. Rate2. Composition3. Volume Effects
Efficiency Ratio
• One measure of the ability to manage costs is the ratio of expenses to revenue
• EFF = Efficiency Ratio
Noninterest ExpenseEFFNII Noninterest Income
Analysis of Non Interest Expense
• We may also want to look carefully at the sources of efficiency with which banks deliver services
% of Assets• Personnel Expenses• Total Expenses• Burden
Productivity Measures
•Efficiency Ratio
•Personnel Expense/Employee
•Assets/Employee
Decomposition of Expenses Banks with Assets > US$50 billion
2004 2003 2002 PERSONNEL EXPENSE 1.44 1.51 1.54OCCUPANCY EXPENSE 0.38 0.43 0.42OTHER OPER EXP(INCL INTANGIBLES) 1.5 1.6 1.61 TOTAL OVERHEAD EXPENSE 3.54 3.74 3.71OVERHEAD LESS NONINT INC 0.65 0.35 0.34OTHER INCOME & EXPENSE RATIOS EFFICIENCY RATIO 56.87 56.09 53.97AVG PERSONNEL EXP PER EMPL($000) 76.12 70.82 67.08ASSETS PER EMPLOYEE ($MILLION) 6.62 6.04 4.69
Determinants of Net Interest Expense
A. Interest Paying liabilities as a share of assets – Volume Effects
B. The interest paid on interest earning liabilities:
1. Rate Effects: Level of interest paid on liabilities of a given type. (TREND Analysis)
2. Composition/Mix Effects: Types of interest bearing liabilities
Cost AnalysisBanks with Assets > US$50 billion
Source: UBPR Custom Peer Group Reports
2004 2003 2002TOTAL-INT BEARING DEPOSITS 1.22 1.2 1.82 TRANSACTION ACCOUNTS 0.61 0.58 0.85 OTHER SAVINGS DEPOSITS 0.72 0.67 1.1 TIME DEPS OVER $100M 2.14 2.25 3 ALL OTHER TIME DEPOSITS 2.56 2.63 3.44 FOREIGN OFFICE DEPOSITS 1.4 1.12 1.75 FEDERAL FUNDS PURCHASED & REPOS 1.47 1.24 1.82OTHER BORROWED MONEY 2.79 3.05 3.68SUBORD NOTES & DEBENTURES 3.9 3.84 4.19ALL INTEREST-BEARING FUNDS 1.52 1.52 2.19
Net Interest Margin & Spread
• Concentrates on Rate & Composition EffectsNIINIM
average Earning Assets
Interest Income Interest ExpensesSpreadaverage Earning Assets average Paying Liabilities
Increasing Competition?
Net In teres t M argin (N II/E arning A s s ets )
3.00%
3.20%3.40%
3.60%3.80%
4.00%4.20%
4.40%
Profits vs. Risk
• Earning high profits in good or even normal times will be easier if the bank is willing to take on some risk.
• But this risk may be more problematic in bad times.
• Important to measure the risk of the banking system as well as the profits.
Types of Risk 1. Credit Risk2. Liquidity Risk3. Market Risk
• Interest Rate Risk• Foreign Exchange Risk• Stock market risk
4. Operational Risk• Business Risk• Legal Risk
5. Off-Balance Sheet Risk
Credit Risk: the risk that a borrower will not pay back interest or principal
on a loan. Evaluating Bank Credit Risk• History of Credit Performance (Charge-
offs) • Future expected losses (non-performing
loans, types of lending, diversification)• Strength of bank preparation (reserves,
earnings coverage).
Liquidity Risk Variation in Net income caused by
banks difficulty in obtaining immediately available funds.
1. Short-term obligations to shareholders2. Liquid Assets3. Other sources of liquidity
Interest Rate Risk Variation in income and market
value due to effects of interest rate changes on profits & present value
of assets and liabilities. • Gap between interest sensitivity of assets
and liabilities at different maturities.• Duration of assets and liabilities of bank.
Off-balance Sheet Items• Commercial Letters of Credit – Banks guarantee
payment on trade related items.• Standby Letters of Credit – Banks make loans
triggered by default on s-t borrowing or commercial paper.
• Loan Commitments – Banks commit to lending on borrowers demand.
• Securitization w/ Recourse• Credit Derivatives – Credit Guarantees• Financial Derivatives – Interest Rate, Forex, etc.
Swaps, Futures & Options.
Comprehensive Risk Management
• Modern banks use computer models to measure market risk.
• Based on historical data on correlations between asset prices and assumptions about the distribution of shocks (i.e. assume shocks are normally distributed) the models will generate a distribution of returns over any horizon.
• Value at Risk models will predict some possible loss which will be the maximum possible loss with some percentage chance over some forecast horizon.
Problems with VAR’s
• Normal distributions assess a very low likelihood of extreme, crisis events.– HKMA recommends balance sheets should
be “stress-tested” against some
• Historical time series models are subject to unexpected structural change.
• Less good at evaluating losses from infrequently traded assets like loans.
Other RisksOperational Risk• Risk that operating
expenses may vary significantly.– Crime & terrorism– Employee error or fraud
Legal Risk• Risk that lawsuits or
unenforcable contracts might affect profitability or solvency
Reputation Risk• Risk that negative
publicity may affect customer base or business opportunities.
Market Measures of Bank Performance
• Financial markets may be a measure of bank performance.
• Equity Markets: Common stock Book-to-Market ratio measures markets perception of growth potential and risk of assets.
• Preferred stock and subordinated debt holders are exposed to downside risk but not upside gains from risky activities. Price of these assets may help measure riskiness of activities.
Reading List
• J.A. Lopez, Methods for Evaluating Value-at-risk Estimates – SF FRB Economic Review, 1999
• Clark, Dick, Hirtle, Stiroh, and William “The Role of Retail Banking in the U.S. Banking Industry: Risk, Return, and Industry Structure NY FRB Economic Review 2007