FIN 4324 Final Exam Study Guide Commercial Bank Administration Dr Jeffrey A Clark 1 Financial Statements of Commercial Banks a Importance of Financial Statement Data i Most banks are not publicly traded and therefore have no observable stock ii Heavily utilized by Regulators in evaluating the safety and soundness of a iii Used by industry analysts and by ownership and management to evaluate or bond prices bank bank performance 1 Report of condition aka Balance Sheet a Balance sheet of a commercial bank reporting information at a single point in time b We will focus on a wholesale bank a bank that focuses its business activities on commercial banking relationships financial statements c Unlike manufacturing corporations the majority of a commercial bank s assets d e Assets are financial assets rather than physical or fixed assets such as buildings or machines In general banks have higher leverage than manufacturing corporations do are the first item listed on a bank s balance sheet And they are grouped into four major subcategories 1 cash and balances due from other depository institutions 2 investment securities 3 loans and leases and 4 other assets i 1 Cash and balances due from other depository institutions item 1 the first item usually listed is vault cash which is composed of currency and coin needed to meet customers daily withdrawals item 2 Deposits at the Federal Reserve are used primarily to meet legal reserve requirements which assist in check clearing wire transfers and the purchase or sale of treasury securities item 3 Deposits at other financial institutions are primarily used to purchase services from those institutions These banks generally purchase services such as check collection check processing fed funds trading and investment advice from correspondent banks a bank that provides services to another commercial bank item 4 Cash items in the process of collection are checks written against accounts at other institutions that have been deposited at the bank Credit is given to the depositor of these checks only after they clear ii iii Consist of items such as interest bearing 2 Investment Securities deposits at other Financial Institutions federal funds sold repurchase agreements RPs or repos U S Treasury and agency securities securities issued by states and political subdivisions municipals mortgage backed securities and other debt and equity securities These securities generate some income for the bank and are used for liquidity risk management purposes Investment securities are highly liquid have low default risk and can usually be traded in secondary markets Banks usually maintain a significant amount of these securities so they can easily meet liquidity needs that arise unexpectedly 3 Loans and Leases sheet and generate the largest flow of revenue income However loans are also the least liquid asset item and the major source of credit and liquidity risk for most banks Leases are used as alternatives to loans when the bank as owner of a physical asset allows a customer to use an asset in return for periodic lease payments Loans are categorized as commercial and industrial C I loans loans secured by real estate individual or consumer loans and other loans Loans are the major items on a bank s balance 1 Commercial and industrial loans roughly 11 88 of banks total assets These loans are used to finance a firm s capital needs equipment purchases and plant expansion 2 Real estate loans roughly 31 49 of banks total assets Primarily mortgage loans and some revolving home equity loans 3 Consumer loans roughly 8 28 of TA Mainly personal or auto 4 Other loans roughly 2 28 of TA Consists of a variety of loans uncommon loans iv part of Loans and Leases Unearned income and allowance for loan and lease losses these two items are contra asset accounts that are deducted from gross loans and leases on the balance sheet to create net loans and leases Unearned income is the amount of income that the bank has received on a loan from a customer but has not yet recorded as income on the income statement The allowances for loans and lease losses is an estimate by the bank s management of the amount of the gross loans and leases that will not be repaid to the bank 1 Net write offs actual loan losses less loan recoveries v Investment securities plus net loans and leases are the earning assets of a depository institution It is these items on the balance sheet that generate interest income and some of the noninterest income vi 4 Other assets consist of items such as premises and fixed assets other real estate owned OREO collateral seized on defaulted loans intangible assets etc Usually make up a small portion of total assets f Liabilities A bank s liabilities consist of various types of deposit accounts and other borrowings used to fund the investments and loans on the asset side of the balance sheet Liabilities vary in terms of their maturity interest payments check writing privileges and deposit insurance coverage i Demand deposits corporations partnerships and governments that pay no explicit interest are transactions accounts held by individuals 1 Corporations are prohibited from using deposits other than demand deposits for transaction account purposes therefore this group consists of the majority of the demand deposit holders iii MMDAs Money Market deposit accounts ii NOW negotiable order of withdrawal account iv Other savings deposits v Retail CDs vi Core Deposits these accounts are similar these accounts are checkable to a demand deposit but pays interest when a minimum balance is maintained but are subject to restrictions on the number of checks written on each account per month the number of preauthorized automatic transfers per month and the minimum denomination of the amount of each check In addition MMDAs impose minimum balance requirements on depositors bank s core deposits The core deposits are deposits of the bank that are stable over short periods of time and thus provide a long term funding source to a bank Time deposits with a face value of 100 000 or more They were created to allow depositors to liquidate their position in these CDs by selling them in the secondary market rather than having to hold them to maturity or requesting that the bank cash in the deposit early Therefore this makes wholesale CDs a negotiable instrument The bank liabilities listed in above in red make up a Time deposits with a face value below 100 000 All savings accounts other than MMDAs vii