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• • • FDIC Website: UBPR, SDI, CTR Overview of Bank Balance Sheets Overview of The Income Statement
1. Components of Profits 2. Profitability Analysis
• 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. . • UBPR – Comprehensive set of quarterly data for every bank in the US collected by Federal Financial Instituting Examination Council. Link. 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.
• Call and Thrift Reports Detailed Balance Sheet and Income Statement for each bank. Link . Link • Statistics on Depositary Institutions Create reports with customized peer groups.Additional Data Additional macro or industry level data from FDIC & Fed linkable from the site.
• Main source of bank data will be bank annual reports. because the data is not as consistent across banks and not reported as frequently.Analyzing Bank Performance in HK • Data less easily available in consistent comparable form. . Most information is available in annual and interim reports on the web. • Less useful.
Analysis • Peer Analysis . Learn About Bank Balance Sheets at HSBC Subsidiary HSBC National Association.Compare with others in same business situation • Trend Analysis – Compare performance with previous periods. USA .
Other 2. Transactions Accounts 2. Loans Liabilities 1. Noninterest Cash & Due from Banks 4. Other Borrowings Equity . Savings and Time Deposits 3. Investment Securities 3.Balance Sheets Assets 1.
470 7.532.873 2.683.116 102.257 25.121 14.467 6.289 883.069.892.250.082 565.4% 11.570 6.101 578.631.081.842.467.565 596.991.486 156.071 77.043 109. Non-Interest Cash and Due from Banks 4 Cash and due from depository institutions 5 Interest-bearing balances D.125.091. Loans 8 Net loans & leases 9 Loan loss allowance B.597.309 1.390 5.203 586.718.716.560 200.0% 5.577.937.599.529.947. Investments 5 Interest-bearing balances 6 Securities 7 Federal funds sold & reverse repos 10 Trading account assets C.883 3.294 2.356.3% 9.967.757.071 7.767 89.378 387. 57890 .959 3.2% 5.612 8.091.035 525.323.842.309 1.3% 39.014. Other 11 Bank premises and fixed assets 12 Other real estate owned 13 Goodwill and other intangibles 14 All other assets 15 Life insurance assets 8743 166.684.791 46.375.289 89.056.837 65.3% 2.272.178 156.894 53.014.796 60.612 22.677.356.1% Source: SDI Cert.358.599.672.Peer Comparison: Assets HSBC National Association 3 Total assets A.182 2.795 430.0% 28.888.
Types of Bank Assets Show Website on Screen • Cash and Funds Due: – Vault Cash – Deposits at Central Bank – Cash items in process of Collection .
Available-for-sale (marked-tomarket) . Trading Account Securities (marked-to-market) 3. Held-to-Maturity (valued at cost) 2. Long-term (>1 year) Accounting 1. • Investments – Deposits at other banks – Lending of central bank reserves (to other banks) – Securities: Maturity 1. Short-term (<1 year) 2.Types of Bank Assets cont.
Composition of Securities HSBC USA Held to m aturity (book value) 6% All Institutions Held to m aturity (book value) 7% Trading account assets 23% Trading account assets 53% Available for sale (fair m arket value) 41% Available for sale (fair m arket value) 70% .
cont.50% 60.59% 4. • Loan loss accounts are contra-assets.06% 0.44% 0.41% 21.91% 14.13% All real estate loans Farm loans Commercial and industrial loans Loans to individuals Total other loans and leases * . • Net Loans and Leases.28% 8. deductions from value of loans which are chosen subjectively (subject to regulatory approval).Types of Bank Assets. Loans to customers less the allowances for loan losses.25% 16. HSBC All USA Institutions 55.43% 18.
4% 51.0% 3.199.Liabilities HSBC USA Total liabilities Transaction accounts Nontransaction accounts Other Liabilities 154.655.585 49.958 Federally Chartered Institutions 7.074 6.0% 44.631 67.429.810.9% 3.235 80.299.942.825.125 44.824 6.571.096.399.514.6% .294 4.2% 443.
Short-term Borrowings . Foreign Office Deposits. Volatile Liabilities in Red Transactions Non Transactions Non Interest Paying Interest Paying Other Volatile Demand Deposits MMDA NOW Small Savings Deposits Savings Time Deposits < 100K Time Deposits > 100K Fed Funds.Types of Liabilities • Deposits: Main source of funding for commercial banks. Brokered Deposits.
. and junior to deposits.Types of Liabilities. • Fed Funds Purchased: Short-term loans from one bank to another with securities as collateral. • Foreign Office Deposits: Deposits at Foreign Subsidiaries. • Other Borrowed Money: Short-term borrowings and commercial paper. • Subordinated Debt: Debt w/ maturity > 1 yr. cont. • Trading liabilities: Obligations of banks’ securities dealers.
Income Statement NII Net Interest Income: Interest Income-Interest Expense .Burden Non-interest Income-Non-interest Expense .PLL + SG -T + XG = NI Provision for Loan Losses and Leases Securities Gains Applicable Taxes Extraordinary Gain Net Income .
909 176.net Net income 0 -3.860 16.814 665.546 888.141 414.797 179.761 3.706 166.689 1.141 800.189 2.895 1.815 4.343 873.830 BURDEN Pre-tax net operating income 855.Statistics For Depository Institutions HSBC National Association Income and Expense Total interest income Total interest expense (Year-to-date) 9/30/2007 6.671 997.824.089 804.937 950.514 585.134 1.213.169 665.736 XG Extraordinary gains .020.364 925.232 159.063 421.845 31.965 SG Securities gains (losses) T Applicable income taxes Income before extraordinary items 292.349.629.465 638.282.398.654.128 439.484.922 .423 72.426.821 Total noninterest expense Salaries and employee benefits Premises and equipment expense Additional noninterest expense 2.759 1.919 1.652 2.787 65.247 NII Net interest income PII Provision for loan and lease losses Total noninterest income Fiduciary activities Service charges on deposit accounts Trading account gains & fees Additional noninterest income 2.674.201.787 958.472 9/30/2006 5.643.
145 4..011 190.264 116.114 275.Net Interest: Key Source of Profits • Main business of commercial banks is taking deposits at interest and making loans or buying interest paying assets.678 32.094 Statistics For Depository Institutions .098. 12/31/2005 Foreign office loans Lease financing receivables Balances due from depository institutions Securities Trading accounts Federal funds sold Other interest income Total 82.005 6. • Net Interest Income (NII) = Interest Revenue – Interest Expenses HSBC USA N.643 870.A.
95% 236.00% Statistics For Depository Institutions U.050 0.114 100.Sources of Interest Income HSBC USA N. All other loans in domestic offices Securities U.00% 83.906 1.49% 682.230 11.419 5.485 6.861.A. 12/31/2005 CTR Domestic Office Loans Loans secured by real estate Loans to finance agricultural production and other loans to farmers Commercial and industrial loans (1) Credit cards (2) Other individual loans Loans to foreign governments and official institutions.71% 812.85% 4.21% 2.22% 168 0.S.013 15.45% 131..05% 530.527.S.616 78.06% 870.234 100. Government agency obligations Mortgage-backed securities All other securities (includes state and municipal) 2. Banks heavily dependent on income from property sector like Hong Kong! . Treasury securities and U.663 63.00% 56.798 17.S.
000 or more (3) Time deposits of less than $100.982 217.000 685 321.635 768. ATS accounts.035 .106.392 578.802 52.Sources of Interest Expense HSBC USA N.A.237 Transaction accounts (NOW accounts..) (1) Savings deposits (includes MMDAs) (2) Time deposits of $100.695 206. 12/31/05 SDI & CTR Domestic office deposits Foreign office deposits Federal funds purchased Trading liabilities and other borrowed money Subordinated notes and debentures 1. etc.807 733.
banks have many financial businesses including credit cards. etc. rent.Other sources of profits • Banks face other expenses (salaries. etc. • Burden = Noninterest Expenses – Noninterest Revenues . Banks have an increasing role in providing services to financial markets.) and have other sources of income such as fees and services. In HK. insurance.
765 US$.A.Sources of Non-Interest Income HSBC USA N.056 Net gains (losses) on sales of other assets (excluding securities) 77.956 Other 709.120 Net gains (losses) on sales of other real estate owned 2.824 Investment banking. and underwriting fees and commissi 10. 000.761 Net gains(losses) on sales of loans 10..983 Venture capital revenue 0 Net servicing fees 48.015 Net securitization income 113. 12/31/2005 SDI Fiduciary activities 87. brokerage. CTR .718 Insurance commission fees and income 32. advisory.341 Service charges on deposit accounts 208.434 Trading account gains & fees 364.
390 Goodwill impairment losses 0 Other noninterest expense 1.Sources of Non-Interest Expense HSBC USA N.A.531 CTR .058 Amortization expense and impairment losses for other intangible losses 4. 12/31/05 SDI Salaries and employee benefits 956.435.378 Premises and equipment expense 237..
• Loan reserves are a contra-asset account.e. • To prevent unexpected losses from leading to fluctuations in profits. 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. i.Loan Provisions • When loans are not repaid. these losses occur they will have a negative impact on profits. . banks create a loan reserve account. an account of deductions from stock of loans.
Etc. • Taxes . • Securities Gains: Changes in Mark-toMarket value of financial assets. • Extraordinary Items: One time gains and losses on asset sales.
Evaluating Bank Performance ROE Analysis .
• Items on the Income Statement are generated over a period of time while items on the Balance sheet are at a point in time. . • Corresponds with a rate of return on investment. dollars of income divided by equity in the bank.e.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.
9% Jun. 30.372.. at ends of 2004 and 2005 compared with income earned over 2005.560 8.142. NI Equity NI/Equity 1.Averaging Stock Variables • Example: Consider equity value of HSBC USA.4% Most appropriate to average balance sheet variables over the year. NI Return on Equity ROE Average Equity . 2004 11. 31. N.016.210 8.A.372 Dec. 2004 12.
.g. • Quarterly (and semi-annual) income statements report on a year-to-date basis. [e.Averages Average of available balance sheets. Annualize. income on 9/30 is the income earned from January through September]. start with end of previous year and take average of end of period balance sheets over the year. • To get appropriate denominator.
836. 2005 Jun.045136 9.HSBC USA Return on Equity Year to Date Averages.210 525.829 12.659 NI/ Annualized AvgeEq ROE 0.372 12.758 319.59% 0.182 11.372. 31. 31.347 11.560 Average Equity 11.888.375.142. 2005 Mar.402.639.08587 8.176 11. 31.823.099 1.02803 11. 30. 2005 Dec. 2005 Sep. Check against UBPR Dec. 30.016.21% .197 11.94% 0.067057 8. 2004 Equity Assets 11.202 11.387.03% 0.281 792.
65 22 58 23 .431 ROA Average Equity 12.259.099 0.563 EM Compare Q-by-Q ROE with UBPR PERCENT OF AVERAGE TOTAL EQUITY: NET INCOME DIVIDENDS RETAINED EARNINGS BANK PG 1 PCT 8.767 22.214.171.124.159 12/31/2005 150.932 12.889 12.000 12.899.140 ROE Averrage Assets 162.29 5.38396 Income 1.943 12.26 1.673.011.888.680 3/31/2006 158. Qtr by Qtr Averages SDI Assets Equity HSBC National Association 12/31/2006 9/30/2006 6/30/2006 165.00624 13.481 11.Last Year HSBC National Assoc.35 12.257.679.08347 0.017 166.631.89 7.753.06 6.059.
• Averages (across quarters) of these daily/weekly averages are used to most accurately calculate yields for UBPR. banking firms construct day-byday or week-by-week averages and report these on a quarterly basis. . such as assets.Quarterly Averages • For some balance sheet variables.
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 NI ROA average Total Assets Profitability of Banks Assets average Total Assets EM average Total Equity Leverage .
• When the leverage (EM) is high. But in periods with negative profits. • A high multiplier multiplies profits when profits are positive. • A high EM is a risk factor since it reduces the amount of assets that can go bad without the bank itself going bankrupt. banks are accepting a lot of deposits and can earn high income levels. negative profits may also be multiplied.Equity Multiplier • Banks’ owners earn profits on the spread between interest on lending and the interest on deposits. Capitalization is a key pillar of bank regulation .
Dupont Analysis ROA Asset Utilization Income Management Expense Ratio Cost Management Tax ROA AU ER average Total Assets .
• AU = Asset Utilization (Revenue Management) Revenues AU average Total Assets • ER = Expense Ratio (Cost Management) Total Operating Expense ER average Total Assets .Dupont Analysis (Bank Version) • ROA for all types of firms can be decomposed into revenue and cost management.
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.II. .
Securities Gains Asset Utilization (UA)
= Non Interest Revenue/ Assets Interest Revenue/ Assets
1. Rate 2. Composition 3. Volume Effects
Non Interest Income is growing as a share of operating income
Non Interest Income as % of Income
45.00% 40.00% 35.00% 30.00% 25.00% % 20.00% 15.00% 10.00% 5.00% 0.00% 1991 USA 1996 Japan 2001
Source: Hoshi and Kashyap, 2002
Determinants of Net Interest Income
Interest Earning assets as a share of assets 1. Volume Effects Earning Assets
2. Rate Effects: Level of interest earned on assets of a given type. 3. Composition/Mix Effects: Types of interest earning assets.
55 2002 6.81 5.52 6.85 1.11 3.Yield Analysis Banks with Assets > US$50 billion TOTAL LOANS & LEASES (TE) LOANS IN DOMESTIC OFFICES REAL ESTATE COMMERCIAL & INDUSTRIAL INDIVIDUAL CREDIT CARD AGRICULTURAL LOANS IN FOREIGN OFFICES TOTAL INVESTMENT SECURITIES(TE) INTEREST-BEARING BANK BALANCES FEDERAL FUNDS SOLD & RESALES 2004 5.36 5.51 5.19 3.63 3.12 1.53 2003 5.31 5.74 5.69 7.09 3.55 6.94 2.51 5.99 6.56 2.99 Source: UBPR Custom Peer Group Reports .48 1.76 4.02 4.91 3.41 4.96 1.23 3.28 3.53 5.09 2.72 4.61 5.
Expense Ratio and Cost Management ER Interest Expenses aTA NonInterest Expenses aTA PLL aTA 1. Composition 3. Rate 2. Volume Effects .
Efficiency Ratio • One measure of the ability to manage costs is the ratio of expenses to revenue • EFF = Efficiency Ratio Noninterest Expense EFF NII 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 .
61 3.6 3.62 2003 1.12 6.54 0.43 1.44 0.Decomposition of Expenses Banks with Assets > US$50 billion PERSONNEL EXPENSE OCCUPANCY EXPENSE OTHER OPER EXP(INCL INTANGIBLES) TOTAL OVERHEAD EXPENSE OVERHEAD LESS NONINT INC OTHER INCOME & EXPENSE RATIOS EFFICIENCY RATIO AVG PERSONNEL EXP PER EMPL($000) ASSETS PER EMPLOYEE ($MILLION) 2004 1.74 0.42 1.08 4.35 56.38 1.51 0.34 53.71 0.04 2002 1.09 70.69 .97 67.54 0.82 6.5 3.87 76.65 56.
Rate Effects: Level of interest paid on liabilities of a given type. (TREND Analysis) 2. Interest Paying liabilities as a share of assets – Volume Effects B. Composition/Mix Effects: Types of interest bearing liabilities . The interest paid on interest earning liabilities: 1.Determinants of Net Interest Expense A.
82 3.1 3 3.67 2.22 0.79 3.58 0.14 2.2 0.12 1.75 1.44 1.Cost Analysis Banks with Assets > US$50 billion TOTAL-INT BEARING DEPOSITS TRANSACTION ACCOUNTS OTHER SAVINGS DEPOSITS TIME DEPS OVER $100M ALL OTHER TIME DEPOSITS FOREIGN OFFICE DEPOSITS FEDERAL FUNDS PURCHASED & REPOS OTHER BORROWED MONEY SUBORD NOTES & DEBENTURES ALL INTEREST-BEARING FUNDS 2004 1.05 3.9 1.84 1.4 1.25 2.24 3.52 2002 1.85 1.56 1.19 Source: UBPR Custom Peer Group Reports .68 4.19 2.52 2003 1.47 2.61 0.82 0.72 2.63 1.
Net Interest Margin & Spread • Concentrates on Rate & Composition Effects NII NIM average Earning Assets Spread Interest Income Interest Expenses average Earning Assets average Paying Liabilities .
00% 3.40% 3.40% 4.00% 20 04 20 02 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 19 78 .20% 4.Increasing Competition? Net Interest Margin (NII/Earning Assets) 4.20% 3.60% 3.80% 3.
• But this risk may be more problematic in bad times. • Important to measure the risk of the banking system as well as the profits. .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.
Types of Risk 1. Liquidity Risk 3. Off-Balance Sheet Risk . Operational Risk 5. Market Risk • • • • • Interest Rate Risk Foreign Exchange Risk Stock market risk Business Risk Legal Risk 4. Credit Risk 2.
Evaluating Bank Credit Risk • History of Credit Performance (Chargeoffs) • Future expected losses (non-performing loans. diversification) • Strength of bank preparation (reserves. types of lending. earnings coverage).Credit Risk: the risk that a borrower will not pay back interest or principal on a loan. .
1. Other sources of liquidity .Liquidity Risk Variation in Net income caused by banks difficulty in obtaining immediately available funds. Liquid Assets 3. Short-term obligations to shareholders 2.
• Duration of assets and liabilities of bank. • Gap between interest sensitivity of assets and liabilities at different maturities.Interest Rate Risk Variation in income and market value due to effects of interest rate changes on profits & present value of assets and liabilities. .
. etc. Futures & Options. Forex. Swaps. • Securitization w/ Recourse • Credit Derivatives – Credit Guarantees • Financial Derivatives – Interest Rate. • Loan Commitments – Banks commit to lending on borrowers demand. • Standby Letters of Credit – Banks make loans triggered by default on s-t borrowing or commercial paper.Off-balance Sheet Items • Commercial Letters of Credit – Banks guarantee payment on trade related items.
• 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.Comprehensive Risk Management • Modern banks use computer models to measure market risk.
. crisis events. – HKMA recommends balance sheets should be “stress-tested” against some • Historical time series models are subject to unexpected structural change.Problems with VAR’s • Normal distributions assess a very low likelihood of extreme. • Less good at evaluating losses from infrequently traded assets like loans.
– 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. .Other Risks Operational Risk • Risk that operating expenses may vary significantly.
• 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. .Market Measures of Bank Performance • Financial markets may be a measure of bank performance.
Lopez. and William “The Role of Retail Banking in the U.A. Return.Reading List • J. Banking Industry: Risk. and Industry Structure NY FRB Economic Review 2007 . 1999 • Clark. Stiroh. Dick. Hirtle.S. Methods for Evaluating Valueat-risk Estimates – SF FRB Economic Review.