Chapter 03 Asia PPT 2019

Chapter 3
Analyzing Bank
Performance
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part.
Commercial Bank Financial
Statements
 Bank Assets
 Loans
 Real Estate
 Commercial
 Individual
 Agricultural
 Other loans in domestic offices
 Loans and leases in foreign offices
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
2
Statements
 Bank Assets
 Adjustment to Loans
 Gross Loans and Leases
 minus
 Unearned Income
 Loan and Lease Loss (Allowance for
Loan Loss or ALL)

 equals
 Net Loans and Leases
3
Statements
 Bank Assets
 Investment Securities
 Short-Term Investments
 One year or less
 Examples:
 Interest-Bearing Deposits Due from
Other Banks
 Fed Funds Sold
 Reverse Repos
 T-Bills
4
Statements
 Bank Assets
 Long-Term Investments
 Over one year
 Examples:
 T-Notes and T-Bonds
 Government Agency Issues
 Foreign and Corporate Bonds
 Mortgage-Backed Securities
 Municipal Securities: General Obligation
 Municipal Securities: Revenue
5
Statements
 Bank Assets
 Held-to-Maturity
 Trading Account
 Available-for-Sale
6
Statements
 Bank Assets
 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
7
Statements
 Bank Assets
 Trading Account
 Objective is to generate trading profits
 Marked-to-Market
 Changes in value (unrealized gains and
losses) ARE reflected on the Income
Statement
 Always a current asset, regardless of
maturity of the underlying security
8
Statements
 Bank Assets
 Available-for-Sale
 For those securities that do not fall into the
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
9
Statements
 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
10
Statements
 Bank Assets
 Other Assets
 Bank Premises
 OREO
 Often foreclosed property

 Banker’s Acceptances
11
12
13
Statements
 Bank Liabilities and Stockholder’s Equity
 Transaction Accounts
 Demand Deposits
 Pays no interest
 Available to all customers
 NOW Accounts
 Pays “market” interest rate
 Not available to for-profit corporations
 ATS Accounts
 Pays “market” interest rate
 Not available to for-profit corporations
14
Statements
 Bank Liabilities and Stockholder’s
Equity
 Transaction Accounts
 MMDAs
 Pays market interest rate
 Limited to six checks per month
 Available to all customers
15
Statements
Equity
 Savings and Time Deposits
 Savings Deposits
 No Maturity
 Time Deposits (CDs)
 “Large” or Jumbo CDs
 Negotiable
 “Small” CDs
16
Statements
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
17
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
18
Statements
Equity
 Non-Core Deposits
 Deposits that are very interest rate
sensitive
 AKA
 Volatile Liabilities
 Hot Money
 Purchased Liabilities
 Short-Term Non-Core Funding
19
Statements
Equity
 Non-Core Deposits
 Consist of:
 Federal Funds Purchased
 Repos
 “Large” Time Deposits
 Brokered Time Deposits
20
Statements
Equity
 All Common and Preferred Equity
 Preferred Stock
 Common Stock
21
Statements
 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
22
Statements
 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
23
Statements
 Interest Income (II)
 minus
 Interest Expense (IE)

 equals
 Net Interest Income (NII)
24
Statements
 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)
25
Statements
 Non-Interest Expense (OE)
 Includes:
 Personnel
 Occupancy
 Technology
 Utilities
 Deposit Insurance Premiums
 Intangible Amortizations
 Goodwill Imparement
26
Statements
 Non-Interest Expense (OE)
 minus

 equals
 Burden
 Non-interest expense is typically larger
than non-interest income

 Reducing the Burden will increase bank
profitability
27
Statements
 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
28
Statements
 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
29
Statements
 Net Interest Income (NII)
 minus
 Burden
 minus
 PLL
 plus
 Realized Security Gains (Losses) (SG)

 equals
30
Statements
 Pre-Tax Net Operating Income (te)
 minus
 Taxes (T)
 minus
 Extraordinary Items
 equals
 Net Income (NI)
31
Statements
 Total Revenue (TR) or Total Operating
Income (TOI)
 Includes:
 Interest Income
 Non-Interest Income
 Realized Security Gains (Losses)
 Analogous to Net Sales
32
Statements
 Total Operating Expense (EXP)
 Includes
 Interest Expense
 Non-Interest Expense
 PLL
 Analogous to COGS + Operating
Expenses
33
Statements
 NI = NII – Burden – PLL + SG – T
34
Relationship Between Balance
Sheet & Income Statement
n m
A  L
i 1
i
j 1
j  NW
n
Interest Income   yi Ai
i  1
m
Interest Expense   c j L j
i  1
whole or in part. 35
Relationship Between Balance
Sheet & Income Statement
 Net Interest Income
 Changes with changes in:
 Composition
 Volume
n m
Net Interest Income   yi Ai   c j L j
i  1 i  1
n m
Net Income   yi Ai   c j L j  Burden - PLL  SG - T
i  1 i  1
36
Return on Equity Model
 Profitability Analysis
 Return on Equity (ROE)
 Return on Assets (ROA)
37
 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
38
 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
39
 Net Income/Average Total Assets
NI TR EXP Taxes
ROA    
aTA aTA aTA aTA
 ROA = AU – ER – TAX
40
 Total Operating Expense/Average Total
Assets
 EXP/aTA
EXP IE OE PLL
ER    
aTA aTA aTA aTA
41
 IE can change due to changes in:
 Volume
 Different levels of liabilities versus
equity
 Composition
 Different mix of liabilities
 Rates
EXP IE OE PLL
ER    
aTA aTA aTA aTA
42
 Non-Interest Expense
 OE can change due to changes in:
 Personnel Expenses
 Occupancy Expenses
 Technology Expenses
 Other Overhead Expenses
EXP IE OE PLL
ER    
aTA aTA aTA aTA
43
 Income: Asset Utilization Components
 Total Revenue
 Includes:
 Interest Income (II)

 Non-Interest Income (OI)
 Realized Security Gains or Losses (SG)
TR II OI SG
AU    
aTA aTA aTA aTA
44
 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 TR II OI SG
AU    
aTA aTA aTA aTA
45
 OI can change due to changes in:
 Fees
 Trust Activities
 Service Charges
 Other Non-Interest Income
TR II OI SG
AU    
aTA aTA aTA aTA
46
 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
47
 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
48
49
Managing Risks and Returns
 Risk Management
 Credit Risk
 Liquidity Risk
 Market Risk
 Operational Risk
 Reputation Risk
 Legal Risk
50
 Risk Management
 Credit Risk
 Historical Loss Rate
 Gross Loan Losses (Charge-offs)

 Recoveries
 Net Losses
 (Charge-offs) - Recoveries
51
 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
52
 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
53
 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
54
 Risk Management
 Credit Risk
 Preparation for Losses
 Lack of Diversification
 High Loan Growth
 Country Risk
55
 Risk Management
 Liquidity Risk
 Funding Liquidity Risk
 Inability to liquidate assts or raise required

funding
 Market Liquidity Risk
56
 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
57
 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
58
 Risk Management
 Market Risk
 Equity and Security Price Risk
 Foreign Exchange Risk
 Foreign Currency Translation Risk

 Commitments and Guarantees
denominated in a foreign currency
59
 Risk Management
 Operational Risk
 Business Interruptions
 Transaction Processing
 Inadequate Information Systems
 Breaches in Internal Controls
 Client Liability
 Legal Risk
 Reputation Risk
60
 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
61
Evaluating Bank Performance:
An Application
 Profitability Analysis for PNC in 2007
62
63
64
65
66
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
67
Bank Equity
 CAMELS Ratings
 Capital Adequacy
 Asset Quality
 Management Quality
 Earnings
 Liquidity
 Sensitivity to Market Risk
68
Bank Equity
 CAMELS Ratings
 Ratings from 1 (best) to 5 (worst)
 1 & 2
 Sound banks
 3
 Some underlying problems
 4&5
 Problem banks
69
Bank Equity
 Performance Characteristics of Banks
by Size
 Large Banks versus Small Banks
 Higher ROE
 Lower NIM
 Higher Charge-offs
 Lower Capital
70
71
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
72
Shadow Banking in EA and SEA
 FSB found that HK SAR and Singapore were among
the largest shadow banking sectors in the world.
 Concerns of shadow banking in China arise from:
 Shadow banks are not supervised or poorly supervised.
 They have linkages with authorized banks.
 Through their bank linkages, they have exposure to
market, credit, maturity and liquidity risks.
 They cause social unrest because of their high interest
rates and unscrupulous debt collection practices.
 They have the potential to undermine the monetary policy
of the economy.
 The government in China (as with other countries) is
formulating policies to rein in shadow banks by controlling
and regulating them.
73
Role of Credit Rating Agencies in
Global Recession from Asian View
 Credit rating agencies have been misunderstood
in what they do. They played an important part in
misdiagnosis of the early warning signs of the
global recession.
 So what are credit ratings?
 An opinion on an entity’s ability to meet to meet its
financial commitments on a timely basis, such as:
 Interest, Repayment of Principal & Preferred dividends
Like a building inspection, a rating tells you if the

building (rated entity) is structurally sound, but not if
it is a good buy.
 They are not recommendations to buy or sell, or
guarantee the worth of a stock or business.
74
Credit Rating Agencies continued
 What can be rated?
 Any financial instrument for which the issuer
is obligated to meet a commitment
 E.g. fixed income securities
 Senior debt, subordinated debt, debt-like
preference shares (i.e. with non-deferrable
dividends)
 Hybrid instruments (stapled securities)
 Capital guaranteed annuities
 These should not be rated: Shares or equity-
like preference shares.
75
 Why get a rating?
Issuers say they get ratings to have deeper access

to the market and to lower their funding costs
 Investors find ratings agencies useful in managing
their internal risk.
 Exhibits 3-16 and 3-17 compare long-term ratings
tables for the “Big 3” ratings agencies
 The “Big 3” act independently in their assessments
though normally very close.
 When they differ, issuers and investors usually look
at two or more ratings to gain better insight and
understanding of the capital market.
 Banks need them to assess counterparties and local
governments and sovereigns for awarding contracts.
76
Comparison Tables of the “Big 3”
Rating Agencies – Investment Grade
77
Comparison Tables of the “Big 3”
Rating Agencies – Speculative Grade
78
 The following two PPTs give detailed
descriptions of what the different Fitch long-term
investment and non-investment ratings denote.
 Similar descriptions may be obtained from both
Moody’s and S&P’s websites.
 The “Big 3” credit ratings agencies are
dominant globally and have 95% of the market.
 US law and many EU member governments
give them sole responsibility for dealing with
major government institutions.
79
Long Term Investment Grade Ratings - Fitch
 AAA- Highest Credit Quality
 ‘AAA’ ratings denote the lowest expectation of credit risk. They are assigned
only in case of exceptionally strong capacity for timely payment of financial
commitments. This capacity is highly unlikely to be adversely affected by
foreseeable events.
AA - Very High Credit Quality
 ‘AA’ ratings denote a very low expectation of credit risk. They indicate very
strong capacity for timely payment of financial commitments. This capacity is
not significantly vulnerable to foreseeable events.
 A - High Credit Quality
 ‘A’ ratings denote a low expectation of credit risk. The capacity for timely
payment of financial commitments is considered strong. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
 BBB - Good Credit Quality
 ‘BBB’ ratings indicate that there is currently a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered
adequate, but adverse changes in circumstances and in economic conditions
are more likely to impair this capacity. This is the lowest investment-grade
category.
Note - “+” or “-” may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to ‘AAA’ rating category or
to categories below ‘CCC’.
80
Long Term Non-Investment Grade Ratings -
Fitch
BB - Speculative
 ’BB’ ratings indicate that there is a possibility of credit risk developing,
particularly as the result of adverse economic change over time; however,
business or financial alternatives may be available to allow financial
commitments to be met. Securities rated in this category are not
investment grade .
B - Highly Speculative
 ‘B’ ratings indicate that significant credit risk is present, but a limited margin
of safety remains. Financial commitments are currently being met;
however, capacity for continued payment is contingent upon a sustained,
favourable business and economic environment.
CCC, CC, C - High Default Probability
 Default is a real possibility. Capacity for meeting financial commitments is
solely reliant upon sustained, favourable business or economic
developments. A ‘CC’ rating indicates that default of some kind appears
probable. ‘C’ ratings signal imminent default.
D - Default
 Indicates an entity has defaulted on its obligations
81
The Difference Between National and
International Ratings
 National Ratings may only be used on the local bond
market. For example, RAM Ratings (Malaysia) rates
many hundreds of debt issues but these ratings are
only used by Malaysian investors.
 National Ratings are usually higher than International
Ratings. Using the above example, RAM Ratings rates
Telekom Malaysia as “AAA”. Fitch rates Telekom
Malaysia as “A-” (A minus) as at February 2014.
 Reason: International Ratings Agencies, such as
Fitch applies its “AAA” rating to the best in the world.
RAM Ratings applies its “AAA” to the best in the
country.
82
The Global Recession and Global Annual
Default Rates by Rating Category: 2004-2012
 Exhibit 3-19 shows S&P’s Global Corporate
Annual Default Rates by category for 2004 to 2012.
 Investment grade entities were relatively stable
apart from 2008 and 2009 ( worst years ).
 Non-investment grade entities (BB-CCC/C) were
quite severely impacted by defaults for a
number of years.
 Exhibit 3-20 shows S&P’s global default rates of
investment grade versus speculative grade entities
between 1981 and 2011.
 Speculative grade entities are much more
volatile than investment grade entities.
83
Global Corporate Annual Default Rates by
Rating Category: 2004 -2012
Default Rates (%)
84
85
Chapter 3
Analyzing Bank
Performance
whole or in part.

Chapter 03 Asia PPT 2019

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Chapter 03 Asia PPT 2019

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Chapter 3

 Other loans in domestic offices

 Loans and leases in foreign offices

Loan Loss or ALL)

 Cash Items in Process of Collection

 Often foreclosed property

 Deposits Held in Foreign Offices

 Issued by a bank subsidiary outside the U.S.

 Interest Expense (IE)

 Net Interest Income (NII)

 Fiduciary (Trust) Income

 Non-Interest Income (OI)

than non-interest income

 Beginning ALL (from Balance Sheet)

 Recall, ALL is a contra-asset account

 Realized Security Gains (Losses) (SG)

 Net Income (NI)

 Net Income/Average Total Assets x

 OE can change due to changes in:

 Interest Income (II)

 Different levels of earning assets to total

Assets - Interest Expense/Average

Income)/Average Earning Assets

 Gross Loan Losses (Charge-offs)

 Total Non-Current Loans

 Provision for Loan Loss

 Inability to liquidate assts or raise required

 Asset or Liability is considered “rate

 Foreign Exchange Risk

 Foreign Currency Translation Risk

 Inadequate Information Systems

 Breaches in Internal Controls

 Liabilities > Assets

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