Chapter Twelve

Commercial Banks
Financial Statements and
Analysis
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CAMELS Ratings
Regulators
Regulatorsuse
useCAMELS
CAMELSratings
ratingsto
toevaluate
evaluatethe
thesafety
safety
and
andsoundness
soundnessof
ofbanks
banks
CAMELS
CAMELSratings
ratingsrely
relyheavily
heavilyon
onfinancial
financialstatement
statementdata
data
Components
Components

Capital
Capitaladequacy
adequacy
Asset
Assetquality
quality
Management
Managementquality
quality
Earnings
Earningsquality
quality
Liquidity
Liquidity
Sensitivity
Sensitivitytotomarket
marketrisk
risk

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CAMELS Ratings
CAMELS
CAMELSratings
ratingsrange
rangefrom
from11to
to55

Composite
Composite1banks
1banksare
arebasically
basicallysound
soundininevery
everyrespect
respect
Composite
Composite2banks
2banksare
arefundamentally
fundamentallysound,
sound,but
butmay
mayhave
have
modest
modestweaknesses
weaknessescorrectable
correctableininthe
thenormal
normalcourse
courseof
ofbusiness
business
Composite
Composite3banks
3banksexhibit
exhibitfinancial,
financial,operational,
operational,or
or
compliance
complianceweaknesses
weaknessesranging
rangingfrom
frommoderately
moderatelysevere
severetoto
unsatisfactory
unsatisfactory
Composite
Composite4banks
4bankshave
havean
animmoderate
immoderatevolume
volumeof
ofserious
serious
financial
financialweaknesses
weaknessesor
oraacombination
combinationof
ofother
otherconditions
conditionsthat
thatare
are
unsatisfactory
unsatisfactory
Composite
Composite5banks
5bankshave
havean
anextremely
extremelyhigh
highimmediate
immediateor
ornear
near
term
termprobability
probabilityof
offailure
failure

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Financial Statements
The
TheFederal
FederalFinancial
FinancialInstitutions
InstitutionsExamination
ExaminationCouncil
Council
(FFIEC)
(FFIEC)prescribes
prescribesuniform
uniformprinciples,
principles,standards,
standards,and
andreport
report
forms
formsfor
fordepository
depositoryinstitutions
institutions

balance
balancesheets
sheetsare
arereported
reportedon
onreport
reportof
ofcondition
conditionforms
forms
income
incomestatements
statementsare
arereported
reportedon
onreport
reportof
ofincome
incomeforms
forms
commercial
commercialbanks
banksreport
reportcontingent
contingentassets
assetsand
andliabilities
liabilitieson
onoffoffbalance-sheet
balance-sheetreports
reports

Retail
Retailbanks
banksfocus
focusbusiness
businessactivities
activitieson
onconsumer
consumerbanking
banking
relationships
relationships
Wholesale
Wholesalebanks
banksfocus
focusbusiness
businessactivities
activitieson
oncommercial
commercial
banking
bankingrelationships
relationships
most
mostwholesale
wholesalebanks
banksalso
alsoengage
engageininretail
retailbanking
banking

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Commercial Bank Assets

Cash
Cashand
andbalances
balancesdue
duefrom
fromother
otherdepository
depositoryinstitutions
institutions
Investment
Investmentsecurities
securities

short-term
short-termsecurities
securities(e.g,
(e.g,Treasury
Treasurybills
billsand
andfed
fedfunds
fundssold)
sold)
long-term
long-termsecurities
securities(e.g.,
(e.g.,Treasury
Treasurybonds,
bonds,munis,
munis,MBSs)
MBSs)

commercial
commercialand
andindustrial
industrial
real
realestate
estate
consumer
consumer
other
otherloans
loans

Loans
Loans

Unearned
Unearnedincome
incomeand
andallowance
allowancefor
forloan
loanand
andlease
leaselosses
losses
Other
Otherassets
assets(e.g.,
(e.g.,fixed
fixedassets,
assets,goodwill,
goodwill,etc.)
etc.)

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Commercial Bank Liabilities

Core
Coredeposits
deposits
demand
demanddeposits
deposits
negotiable
negotiableorder
orderof
ofwithdrawal
withdrawal(NOW)
(NOW)accounts
accounts
money
moneymarket
marketdeposit
depositaccounts
accounts(MMDAs)
(MMDAs)
other
othersavings
savingsdeposits
deposits
retail
retailcertificates
certificatesof
ofdeposits
deposits

Other
Otherdeposits
deposits
wholesale
wholesalecertificates
certificatesof
ofdeposits
deposits

negotiable
negotiableinstruments
instrumentstraded
tradedininsecondary
secondarymarkets
markets
brokered
brokereddeposits
deposits

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Commercial Bank
Liabilities and Equity
Non-deposit
Non-depositliabilities
liabilities
borrowed
borrowedfunds
funds

fed
fedfunds
fundspurchased
purchasedand
andrepos
repos
other
otherborrowed
borrowedfunds
funds(e.g.,
(e.g.,bankers
bankersacceptances,
acceptances,commercial
commercial
paper,
discount
window
loans)
paper, discount window loans)

subordinated
subordinatednotes
notesand
anddebentures
debentures
other
otherliabilities
liabilities

accrued
accruedinterest,
interest,deferred
deferredtaxes,
taxes,dividends
dividendspayable,
payable,etc.
etc.

Equity
Equity

preferred
preferredand
andcommon
commonstock
stock
surplus
surplusor
oradditional
additionalpaid
paidin
incapital
capital
retained
retainedearnings
earnings

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Off-Balance-Sheet Items
Off-balance-sheet
Off-balance-sheetitems
itemsare
arecontingent
contingentassets
assetsand
andliabilities
liabilitiesthat
that
may
mayaffect
affectaacommercial
commercialbanks
banksbalance
balancesheet
sheetand/or
and/orincome
income
statement
statement
Loan
Loancommitments
commitments

up-front
up-frontfees
feesare
arecharged
chargedfor
formaking
makingfunds
fundsavailable
available
commitments
commitmentsfees
feesare
arecharged
chargedon
onunused
unusedportion
portionof
ofcommitments
commitments

commercial
commercialletters
lettersof
ofcredit
credit
standby
standbyletters
lettersof
ofcredit
credit

Letters
Lettersof
ofcredit
credit
Loans
Loanssold
sold

loans
loanscan
canbe
besold
soldwith
withor
orwithout
withoutrecourse
recourse

Derivative
Derivativecontracts
contracts

futures,
futures,forwards,
forwards,swaps,
swaps,and
andoptions
options

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Income Statement
Interest
Interestincome
incomeinterest
interestexpense
expense==net
netinterest
interest
income
income
Noninterest
Noninterestincome
incomenoninterest
noninterestexpense
expense==net
net
noninterest
noninterestincome
income
Net
Netinterest
interestincome
incomeprovision
provisionfor
forloan
loanlosses
losses++net
net
noninterest
noninterestincome
income==income
incomebefore
beforetaxes
taxesand
and
extraordinary
extraordinary items
items(EBTEI)
(EBTEI)
EBTEI
EBTEIincome
incometaxes
taxesextraordinary
extraordinaryitems
items==net
net
income
income
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Income Statement
There
Thereisisaadirect
directrelationship
relationshipbetween
betweenthe
theincome
incomestatement
statement
and
andthe
thebalance
balancesheet
sheetof
ofcommercial
commercialbanks
banks
N

n 1

NI rn An rm Lm P NII NIE T
NI
NI==net
netincome
income
AAn ==dollar
dollarvalue
valueofofthe
thebanks
banksnth
nthasset
asset
n
LLm ==dollar
value
of
the
banks
mth
liability
dollar value of the banks mth liability
m
rrn =
rate
earned on the banks nth asset
n = rate earned on the banks nth asset
rrm ==rate
ratepaid
paidon
onthe
thebanks
banksmth
mthliability
liability
m
PP==provision
for
loan
losses
provision for loan losses
NII
=
NII =non-interest
non-interestincome
incomeearned,
earned,including
includingincome
incomefrom
fromOBS
OBSactivities
activities
NIE
NIE==non-interest
non-interestexpenses
expenses
TT ==taxes
taxesand
andextraordinary
extraordinaryitems
items
NN==number
of
assets
the
bank
number of assets the bankholds
holds
M
=
number
of
liabilities
the
bank
M = number of liabilities the bankholds
holds
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Financial Statement Analysis

Financial
Financialstatement
statementanalysis
analysisisisbased
basedon
onaccounting
accounting
ratios
ratios
Time
Timeseries
seriesanalysis
analysisisisthe
theanalysis
analysisof
offinancial
financial
statements
statementsover
overaaperiod
periodof
oftime
time
Cross-sectional
Cross-sectionalanalysis
analysisisisthe
theanalysis
analysisof
offinancial
financial
statements
statementscomparing
comparingone
onefirm
firmwith
withothers
others

the
theUniform
UniformBank
BankPerformance
PerformanceReport
Report(UBPR)
(UBPR)maintained
maintainedby
bythe
the
FFIEC
FFIECallows
allowsbanks
bankstotoobserve
observecompetitor
competitorfinancial
financialstatements
statements

Most
Mostfinancial
financialstatement
statementanalyses
analysesisisaacombination
combinationof
oftime
time
series
seriesanalysis
analysisand
andcross-sectional
cross-sectionalanalysis
analysis
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Return on Equity (ROE) Framework

Return
Returnon
onEquity
Equity(ROE)
(ROE)analysis
analysisbegins
beginswith
withROE
ROEand
and
then
thenbreaks
breaksititdown
downinto
intoits
itscomponents
components
ROE
ROEmeasures
measuresthe
theoverall
overallprofitability
profitabilityof
ofthe
thebank
bankper
per
dollar
dollarof
ofequity
equity
net income
ROE
total equity capital

ROE
ROEcan
canbe
bebroken
brokendown
downinto
intoits
itscomponents
components
ROE

McGraw-Hill/Irwin

net income
total assets

ROA EM
total assets total equity capital

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Return on Equity (ROE) Framework

Return
Returnon
onAssets
Assets(ROA)
(ROA)measures
measuresprofit
profitgenerated
generated
relative
relativethe
thebanks
banksassets
assets
Equity
EquityMultiplier
Multiplier(EM)
(EM)measures
measuresthe
theextent
extentto
towhich
which
assets
assetsare
arefunded
fundedwith
withequity
equityrelative
relativeto
todebt
debt(i.e.,
(i.e.,ititisisaa
measure
measureof
ofleverage)
leverage)
ROA
ROAcan
canalso
alsobe
bebroken
brokendown
downinto
intoits
itscomponents
components
net income
total operating income
ROA

total operating income

total assets
PM AU

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Return on Equity (ROE) Framework

Profit
ProfitMargin
Margin(PM)
(PM)measures
measuresthe
theability
abilityto
topay
payexpenses
expensesand
and
generate
generatenet
netincome
incomefrom
frominterest
interestand
andnoninterest
noninterestincome
incomeand
andisis
composed
composedof
of

interest
interestexpense
expenseratio
ratio
provision
provisionfor
forloan
loanloss
lossratio
ratio
noninterest
noninterestexpense
expenseratio
ratio
tax
taxratio
ratio

interest
interestincome
incomeratio
ratio
noninterest
noninterestincome
incomeratio
ratio

Asset
AssetUtilization
Utilization(AU)
(AU)measures
measuresthe
theamount
amountof
ofinterest
interestand
and
noninterest
noninterestincome
incomegenerated
generatedper
perdollar
dollarof
oftotal
totalassets
assetsand
andisis
composed
composedof
of

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Other Ratios
The
Thenet
netinterest
interestmargin
margin(NIM)
(NIM)measures
measuresthe
thenet
netreturn
return
on
onaabanks
banksearning
earningassets
assets
NIM

net interest income

interest income interest expense

earning assets
investment securities net loans and leases

The
Thespread
spreadmeasures
measuresthe
thedifference
differencebetween
betweenthe
the
average
averageyield
yieldon
onearning
earningassets
assetsand
andaverage
averagecost
coston
on
interest-bearing
interest-bearingliabilities
liabilities
Spread

McGraw-Hill/Irwin

interest income
interest expense

earning assets interest - bearing liabilities

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2009 The McGraw-Hill Companies, All Rights

Other Ratios
Overhead
Overheadefficiency
efficiencymeasures
measuresaabanks
banksability
abilityto
to
generate
generatenoninterest
noninterestincome
incometo
tocover
covernoninterest
noninterestexpenses
expenses
Overhead efficiency

noninterest income
noninterest expense

Many
Manyadditional
additionalratios
ratiosare
arecommonly
commonlyused
usedto
toanalyze
analyze
commercial
commercialbanks
banksby
by breaking
breakingdown
downthe
thecomponents
components
of
ofROE
ROEeven
evenfurther
further(see
(seeTables
Tables12-6
12-6and
and12-7)
12-7)

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The Impact of Market Niche and Size

Retail
Retail and
and wholesale
wholesale commercial
commercial banks
banks operate
operate in
in
different
different market
market niches
niches that
that should
should be
be noted
noted when
when
performing
performing financial
financial statement
statement analysis
analysis
Webster
Webster Financial
Financial Bancorp
Bancorp (WBS)
(WBS)
WBS
WBSisisaaprofitable
profitableand
andefficient
efficientretail
retailbank
bank
invests
investsmainly
mainlyin
inreal
realestate
estateloans
loans
uses
useslow
lowcost
costretail
retaildeposits
depositsto
tofund
fundits
itsassets
assets
holds
holdsrelatively
relativelymore
moreequity
equitycapital
capitalthan
thanBank
Bankof
of
America
America
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The Impact of Market Niche and Size

Bank
Bank of
ofAmerica
America (BOA)
(BOA)
BOA
BOAisisboth
bothaaretail
retailand
andaawholesale
wholesalebank
bank
has
hasaarelatively
relativelymore
morediversified
diversifiedportfolio
portfoliothan
thanWBS
WBS
uses
usesaabroader
broaderarray
arrayof
ofdeposits
depositsand
andmore
morepurchased
purchased
funds
funds(i.e.,
(i.e.,fewer
fewercore
coredeposits)
deposits)than
thanWBS
WBS
offers
offersaabroad
broadspectrum
spectrumof
offinancial
financialservices
services

BOA
BOAisis the
the more
more profitable
profitable bank
bank
uses
usesless
lessequity,
equity,which
whichcontributes
contributesto
toaahigher
higherROE
ROE
generates
generatesmuch
muchmore
morenoninterest
noninterestincome
income
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