BANK MANAGEMENT

www.uel.edu.vn

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 Analyzing
Bank Performance

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Agenda

1 Commercial Bank Financial Statements

The Relationship between the Balance Sheet
2 and Income Statement

3 The Return on Equity Model

4 Managing Risk and Returns

5 Financial Statement Manipulation

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Analyzing Bank Performance
❖In 2008, depository institutions reported:
▪ Worsening asset quality leading to higher
charge-offs
▪ Shrinking net interest income
▪ Declining non-interest income
• These factors led to lower profits, ROE, ROA, and
bank failures

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Analyzing Bank Performance
❖Depository Institution Failures
▪ Over 1,500 bank failures between 1985 and
1993
▪ 0 in 2005 or 2006
▪ 3 in 2007
▪ Sharp increase in 2008 and 2009
• 26 in 2008
• 72 through mid-August 2009

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Vietnam Interest Rate 2000-2020

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Commercial Bank Financial Statements

❖Most depository financial institutions own

few fixed assets and thus exhibit low
operating leverage
❖Many bank liabilities carry short-term
maturities. As a result, interest expense
changes coincidentally with short-run
changes in market interest rates

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Deposit Interest Rate in Vietnam

9 https://tradingeconomics.com/vietnam/deposit-interest-rate
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Deposit Interest Rate in Vietnam:Forecast

10 https://tradingeconomics.com/vietnam/deposit-interest-rate
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Commercial Bank Financial Statements

❖In the US: Many commercial bank

deposits are insured by the FDIC (Federal
Deposit Insurance Corporation). Insured
deposits carry below-market interest rates
❖In Vietnam?
❖Banks operate with less equity capital
than non-financial companies, which
increases financial leverage and the
volatility of earnings

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Opportunities and risks to the bank manager

❖Because their function is primarily

financial, most depository institutions own
few fixed assets and thus exhibit low
operating leverage
❖Many bank liabilities are payable on
demand or carry short-term maturities so
depositors can renegotiate deposit rates
as market interest rates change. As a
result, interest expense changes
coincidentally with short-run changes in
market interest rates, thereby creating
significant asset allocation and pricing
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Opportunities and risks to the bank manager

❖Many commercial bank deposits are

insured by the FDIC. Thus, if the bank
fails, the deposit holder is guaranteed
payment for the insured amount. Insured
deposits carry below-market interest
rates.
❖Banks operate with less equity capital
than nonfinancial companies, which
increases financial leverage and the
volatility of earnings

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Commercial Bank Financial Statements

❖What statements are there in

financial statements of a company
(bank)?

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Commercial Bank Financial Statements

❖Financial statements of a company (bank)

include:
- Financial condition statement (The Balance
sheet);
- Business performance statement (The
Income Statement );
- Cash flow statement;
- Note to financial statements;
- Other statements defined by law

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The Balance sheet

❖A bank’s balance sheet presents financial

information comparing what a bank owns
with what it owes and the ownership
interest of stockholders. Assets indicate
what the bank owns; liabilities represent
what the bank owes; and equity refers to
the owners’ interest such that:

Assets = Liabilities + Equity

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The Balance sheet
❖Balance sheet figures are stock values
calculated for a particular day or point in
time.
❖Values on the balance sheet represent the
balance of cash, loans, investments,
and property owned by the bank on a
particular day.
❖Regulators require to report (in the US
and in Vietnam):
▪ Monthly?
▪ Quarterly?
▪ Yearly?
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The Balance sheet

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The Balance sheet

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The Balance sheet

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The Balance sheet

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Bank Assets:Loans

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Bank Assets:Loans

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The Balance sheet

❖Bank Assets
▪ Adjustment to Loans
• Gross Loans and Leases
– minus
• Loan and Lease Loss (Allowance for Loan Loss or
ALL)
equals
• Net Loans and Leases

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The Balance sheet

❖Bank Assets
▪ Investment Securities
• Short-Term Investments
– One year or less
– Examples:
» Interest-Bearing Deposits Due from Other Banks
» T-Bills

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The Balance sheet

❖Bank Assets
▪ Investment Securities
• Long-Term Investments
– Over one year
– Examples:
» T-Notes and T-Bonds
» Government Agency Issues
» Foreign and Corporate Bonds

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The Balance sheet

❖Bank Assets
▪ Investment Securities
• Held-to-Maturity
• Available-for-Sale

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The Balance sheet

❖Bank Assets
▪ Investment Securities
• Available-for-Sale
– For those securities that do not fall into the Held-to-
Maturity (HTM) or Trading categories
– Market-to-Market
– Change in value (unrealized gains or losses) ARE
reflected on the Balance Sheet (Change to Shareholder’s
Equity)
– May be a current or long-term asset, depending on
maturity

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The Balance sheet

❖Bank Assets
▪ Investment Securities
• Held-to-Maturity
– Intent and ability to hold until maturity
– Recorded at cost (Book Value)
– Changes in value (unrealized gains or losses) are NOT
reflected on the balance sheet or income statement
– May be a current or long-term asset, depending on
maturity

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The Balance sheet

❖Bank Assets
▪ Non-Interest Cash and Due From Banks
• Vault Cash
• Deposits held at the Federal Reserve
• Cash Items in Process of Collection (CIPC)
– Largest component of this category

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The Balance sheet

❖Bank Assets
▪ Other Assets
• Bank Premises
• Banker’s Acceptances

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The Balance sheet
❖Bank Liabilities and Stockholder’s Equity
▪ Transaction Accounts
• Demand Deposits
– Pays no interest
– Available to all customers
• Negotiable Order of Withdrawal (NOW) Accounts
– Pays “market” interest rate
– Not available to for-profit corporations
• Automatic Transfer Service (ATS) Accounts
– Pays “market” interest rate
– Not available to for-profit corporations

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The Balance sheet
❖Bank Liabilities and Stockholder’s Equity
▪ Transaction Accounts
• Money market deposit accounts (MMDAs)
– Pays market interest rate
– Limited to six checks per month
– Available to all customers

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The Balance sheet
❖Bank Liabilities and Stockholder’s Equity
▪ Savings and Time Deposits
• Savings Deposits
– No Maturity
• Time Deposits (CDs)
– “Large” or Jumbo CDs
» Negotiable
– “Small” CDs

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Commercial Bank Financial Statements

❖Bank Liabilities and Stockholder’s Equity

▪ Other Borrowings
• Fed Funds Purchased Repurchase Agreements
• Brokered Deposits
• Deposits Held in Foreign Offices
– Issued by a bank subsidiary outside the U.S.
• Federal Home Loan Bank Borrowings
• Subordinated Notes and Debentures

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Commercial Bank Financial Statements

❖Bank Liabilities and Stockholder’s Equity

▪ Core Deposits
• Deposits that are NOT very interest rate sensitive
• Represent permanent funding base
• Made up of:
– Demand Deposits
– NOW and ATS accounts
– MMDAs
– Savings Accounts
– “Small” Time Deposits

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Commercial Bank Financial Statements

❖Bank Liabilities and Stockholder’s Equity

▪ Non-Core Deposits
• Deposits that are very interest rate sensitive
• Also Know As (AKA)
– Volatile Liabilities
– Hot Money
– Purchased Liabilities
– Short-Term Non-Core Funding

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The Balance sheet
❖Bank Liabilities and Stockholder’s Equity
▪ Non-Core Deposits
• Consist of:
– Federal Funds Purchased
– Repos
– “Large” Time Deposits
– Brokered Time Deposits

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The Balance sheet
❖Bank Liabilities and Stockholder’s Equity
▪ All Common and Preferred Equity
• Preferred Stock
• Common Stock

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Comparison
❖https://data.worldbank.org/

❖Compare the changes of deposits and

loans between Vietnam and other
countries in ASEAN.

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The Income Statement
❖Income Statement
▪ Interest Income (II)
• Includes interest and fees from:
– Loans
– Deposits at other institutions
– Trading Account Securities
– Municipal Securities
» Estimated Tax Benefit =
» Municipal Interest Rate/(1 – Marginal Tax Rate) =
Tax-Equivalent Municipal Interest Income

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The Income Statement
❖Income Statement
▪ Interest Expense (IE)
• Includes interest paid on all interest-bearing
liabilities:
– NOW Accounts
– ATS Accounts
– MMDAs
– Savings Accounts
– Time Deposits
– Non-Core Liabilities
– Long-Term Debt

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The Income Statement
❖Income Statement
▪ Interest Income (II)
• minus
▪ Interest Expense (IE)
• equals
▪ Net Interest Income (NII)

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The Income Statement
❖Income Statement
▪ Non-Interest Income (OI)
• Includes:
– Fiduciary (Trust) Income
– Deposit Service Charges
– Trading Revenues
– Investment Banking Fees and Commissions
– Insurance Commission Fees and Income
– Net Servicing Fees
– Net Gains (Losses) on Sales of Loans
– Other Net Gains (Losses)

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The Income Statement
❖Income Statement
▪ Non-Interest Expense (OE)
• Includes:
– Personnel
– Occupancy
– Technology
– Utilities
– Deposit Insurance Premiums
– Intangible Amortizations
– Goodwill Imparement

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The Income Statement
❖Income Statement
▪ Non-Interest Expense (OE)
• minus
▪ Non-Interest Income (OI)
• equals
▪ Burden
• Non-interest expense is typically larger than non-
interest income
• Reducing the Burden will increase bank
profitability

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The Income Statement
❖Income Statement
▪ Provision for Loan and Lease Losses (PLL)
• Estimate of potential losses on loans
• Relationship between PLL and ALL
– Beginning ALL (from Balance Sheet)
» plus
– This year’s PLL (from Income Statement)
» minus
– Charge-offs
» plus
– Recoveries
» Equals
– Ending ALL

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The Income Statement
❖Income Statement
▪ Provision for Loan and Lease Losses (PLL)
• Relationship between PLL and ALL
– Recall, ALL is a contra-asset account
» When a loan is charged off, Gross Loans and the
ALL account are decreased by the same amount

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The Income Statement
❖Income Statement
▪ Net Interest Income (NII)
• minus
▪ Burden
• minus
▪ PLL
• plus
▪ Realized Security Gains (Losses) (SG)
• equals

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The Income Statement
❖Income Statement
▪ Pre-Tax Net Operating Income (te)
• minus
▪ Taxes (T)
• minus
▪ Extraordinary Items
• equals
▪ Net Income (NI)

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The Income Statement
❖Income Statement
▪ Total Revenue (TR) or Total Operating
Income (TOI)
• Includes:
– Interest Income
– Non-Interest Income
– Realized Security Gains (Losses)
• Analogous to Net Sales

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The Income Statement
❖Income Statement
▪ Total Operating Expense (EXP)
• Includes
– Interest Expense
– Non-Interest Expense
– PLL
• Analogous to COGS + Operating Expenses

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The Income Statement
❖Income Statement
▪ NI = NII – Burden – PLL + SG – T

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 Relationship Between Balance Sheet & LOGO
Income Statement
❖Ai = Dollar magnitude of the ith asset
❖Lj = Dollar magnitude of the jth liability
❖NW = Dollar magnitude of equity
❖yi = Average pre-tax yield on the ith asset
❖cj = Average pre-tax cost on the jth
liability

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Relationship Between Balance Sheet & Income LOGO
Statement

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 Relationship Between Balance Sheet & LOGO
Income Statement
❖Net Interest Income
▪ Changes with changes in:
• Composition
• Volume

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Return on Equity Model
❖Profitability Analysis
▪ Return on Equity (ROE)
▪ Return on Assets (ROA)

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Return on Equity Model
❖Profitability Analysis
▪ Return on Equity
• Net Income/Average Total Equity
• ROA x EM
– Net Income/Average Total Assets x
Average Total Assets/Average Total Equity

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Return on Equity Model
❖Expense Ratio and Asset Utilization
▪ Asset Utilization (AU)
• Total Revenue/Average Total Assets
– TR/aTA
▪ Expense Ratio (ER)
• Total Operating Expenses/Average Total Assets
– EXP/aTA
▪ Tax Ratio (TAX)
• Taxes/Average Total Assets

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Return on Equity Model
❖Expense Ratio and Asset Utilization
• Net Income/Average Total Assets

• ROA = AU – ER – TAX

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Return on Equity Model
❖Expense Ratio and Asset Utilization
▪ Expense Ratio (ER)
• Total Operating Expense/Average Total Assets
– EXP/aTA

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Return on Equity Model
❖Expense Ratio and Asset Utilization
▪ Expense Ratio (ER)
• IE can change due to changes in:
– Volume
» Different levels of liabilities versus equity
– Composition
» Different mix of liabilities
– Rates

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Return on Equity Model
❖Expense Ratio (ER)
• Non-Interest Expense
• OE can change due to changes in:
– Personnel Expenses
– Occupancy Expenses
– Technology Expenses
– Other Overhead Expenses

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Return on Equity Model
❖Income: Asset Utilization Components
▪ Total Revenue
• Includes:
– Interest Income (II)
– Non-Interest Income (OI)
– Realized Security Gains or Losses (SG)

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Return on Equity Model
❖Income: Asset Utilization Components
▪ II can change due to changes in:
• Volume
– Different levels of earning assets to total assets
– Earnings Base (EB) = Average Earning Assets/aTA
• Composition
– Different mix of earning assets
• Rates

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Return on Equity Model
❖Income: Asset Utilization Components
▪ Non-Interest Income (OI)
• OI can change due to changes in:
– Fees
– Trust Activities
– Service Charges
– Other Non-Interest Income

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Return on Equity Model
❖Aggregate Profitability Measures
▪ Net Interest Margin (NIM)
• Net Interest Income/Average Earning Assets
▪ Spread
• Interest Income/Average Earning Assets - Interest
Expense/Average Interest-Bearing Liabilities

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Return on Equity Model
❖Aggregate Profitability Measures
▪ Burden
• (Non-Interest Expense – Non-Interest
Income)/Average Earning Assets
– Lower numbers are better
▪ Efficiency Ratio
• Non-Interest Expense/(Net Interest Income + Non-
Interest Income)
– Lower numbers are better

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
▪ Liquidity Risk
▪ Market Risk
▪ Operational Risk
▪ Reputation Risk
▪ Legal Risk

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
• Historical Loss Rate
– Gross Loan Losses (Charge-offs)
– Recoveries
– Net Losses
» Charge-offs - Recoveries

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
• Expected Future Losses
– Past-Due Loans
» Interest and Principal has not been paid but it is still
accruing interest
» 30-89 days
» 90 days and over
– Non-Performing Loans
» 90 days or more past-due
– Non-Accrual Loans
» Not accruing interest

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
• Expected Future Losses
– Total Non-Current Loans
» Non-Performing + Non-Accrual Loans
– Restructured Loans
– Classified Loans
» Regulations force management to set aside reserves
for loans that are clearly not going to be paid back

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
• Preparation for Losses
– Provision for Loan Loss
» IRS versus FASB and Regulators
– Earnings Coverage of Net Losses
» (Net Interest Income – Burden)/Net Loan and Lease
Losses
» Management can manipulate by delaying the
recognition of bad loans

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Managing Risks and Returns
❖Risk Management
▪ Credit Risk
• Preparation for Losses
– Lack of Diversification
– High Loan Growth
– Country Risk

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Managing Risks and Returns
❖Risk Management
▪ Liquidity Risk
• Funding Liquidity Risk
– Inability to liquidate assets or raise required funding
• Market Liquidity Risk

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Managing Risks and Returns
❖Risk Management
▪ Liquidity Risk
• Holding Liquid Assets
– Pledging Requirements
– Cash Assets
» Not a good source of liquidity for a bank
• Ability to Borrow for Liquidity
– Volatile Liabilities
» “Hot Money” versus Core Deposits
» Large CDs
» Fed Funds Purchased
» Repos

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Managing Risks and Returns
❖Risk Management
▪ Market Risk
• Interest Rate Risk
– Asset or Liability is considered “rate sensitive” if it can be
re-priced during a particular time period
– GAP/Earnings Sensitivity Analysis
» Changes in spread/NIM due to changes in rates
– Duration GAP
» Market Value of Equity Sensitivity

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Managing Risks and Returns
❖Risk Management
▪ Market Risk
• Equity and Security Price Risk
• Foreign Exchange Risk
– Foreign Currency Translation Risk
» Commitments and Guarantees denominated in a
foreign currency

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Managing Risks and Returns
❖Risk Management
▪ Operational Risk
• Business Interruptions
• Transaction Processing
• Inadequate Information Systems
• Breaches in Internal Controls
• Client Liability
▪ Legal Risk
• Reputation Risk

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Managing Risks and Returns
❖Risk Management
▪ Capital or Solvency Risk
• Risk of becoming insolvent
– Liabilities > Assets
▪ Off-Balance Sheet Risk
• Tier 1 Capital
– Common Equity + Non-cumulative Preferred Stock
• Risk-Weighted Assets

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Evaluating Bank Performance: An Application

❖Profitability Analysis for VCB in 2021?

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Maximizing the Market Value of Bank Equity

❖Effective Management of:

▪ Assets
▪ Liabilities
▪ Off-Balance Sheet Activities
▪ Interest Rate Margin
▪ Credit risk
▪ Liquidity
▪ Non-Interest Expense
▪ Taxes

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Maximizing the Market Value of Bank Equity

❖CAMELS Ratings
▪ Capital Adequacy
▪ Asset Quality
▪ Management Quality
▪ Earnings
▪ Liquidity
▪ Sensitivity to Market Risk

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Maximizing the Market Value of Bank Equity

❖CAMELS Ratings
▪ Ratings from 1 (best) to 5 (worst)
• 1&2
– Sound banks
•3
– Some underlying problems
• 4&5
– Problem banks

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Maximizing the Market Value of Bank Equity

❖Performance Characteristics of Banks by

Size
▪ Large Banks versus Small Banks
• Higher ROE
• Lower NIM
• Higher Charge-offs
• Lower Capital

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Financial Statement Manipulation
❖Off-Balance Sheet Activities
▪ Window Dressing
▪ Preferred Stock
▪ Non-Performing Loans
▪ Allowance for Loan Losses
▪ Securities Gains and Losses
▪ Non-Recurring Extraordinary Items

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Thank you

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