MODULE 02

1. FINANCIAL STATEMENTS OF BAKS

1.1. Questions
The Balance Sheet of a bank
1) What are the principal accounts that appear on a bank balance sheet?
2) Which accounts are most important, which are least important on the asset side of a bank balance
sheet?
3) What accounts are most important on the liability side of a balance sheet?
4) What are the essential differences among demand deposits and time deposits?
5) What are primary reserves and secondary reserves and what are they supposed to do?
6) Suppose that a bank holds cash in its vault of $14 million, short-term government securities of $12.4
million, privately issues money market instruments of $5,2 million, deposits at the Federal Reserves
banks of $20.1 million, cash items in the process of collection of 6.6 million, and deposits placed with
other banks of 16.4 million. How much does this bank hold in primary reserves? In secondary reserve?
7) What are off-balance sheet items and why are they important to some financial firms?
8) Why are bank accounting practices under attack right now? In what way could financial institutions
improve their accounting methods?
Report of Income for a bank
1) What accounts make up the Report of Income of a bank?
2) In rank order, what are the most important revenue and expense items on a Report of Income?
3) What is the relationship between the provision for loan loss on a bank’s Report of Income and the
allowance for loan losses on its Report of Condition?
4) Suppose a bank has an allowance for loan losses of $1.25 million at the beginning of the year, changes
current income foe $250,000 provision for loan losses, charges off worthless loans of $150,000, and
recovers $50,000 on loans previously charged off. What will be the balance in the allowance for loan
losses at year end?

1.2. Exercises
Question 1) Jasper National Bank has just submitted its Report of Condition to the FDIC. Please fill in the
missing items from its statement shown below (all figures in millions of dollars):

Item Amount
Total assets 1,400
Cash and due from depository institutions 87
Securities ____
Federal funds sold and reverse repurchase agreements 24
Gross loans and leases 1,131
Loan loss allowance ____
Net loans and leases 1,131
Trading account assets 2
Bank premises and fixed assets 12
Other real estate owned 2
Goodwill and other intangibles 5
All other assets 67
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 Item Amount
Total liabilities and capital 1,400
Total liabilities ____
Total deposits 904
Federal funds purchased and repurchase agreements 81
Trading liabilities 0
Other borrowed funds 25
Subordinated debt ____
All other liabilities 42
Item Amount
Total equity capital 138
Perpetual preferred stock 0
Common stock 3
Surplus ____
Undivided profits 62

Question 2) Along with the Report of Condition submitted above, Jasper has also prepared a Report of
Income for the FDIC. Please fill in the missing items from its statement shown below (all figures in
millions of dollars):
Interest Income
Item Amount
Total interest income 63
Total interest expense 18
Net interest income ____
Provision for loan and lease losses 3
Noninterest Income

Item Amount
Total noninterest income 39
Fiduciary activities 2
Service charges on deposit accounts 6
Trading account gains and fees ____
Additional noninterest income 30
Noninterest Expenses

Item Amount
Total noninterest expense 42
Salaries and employee benefits ____
Premises and equipment expense 5
Additional noninterest expense 15
Final Income Calculation

Item Amount
Pretax net operating income ____
Securities gains (losses) 1

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 Applicable income taxes 13
Income before extraordinary items ____
Extraordinary gains — net 0
Net income ____

Question 3) Given Financial Data

Item Amount
Total interest income 290
Total interest expenses 205
Total noninterest income 27
Total noninterest expenses 40
Provision for loan losses 10
Income taxes 15
Dividends to common stockholders 11
Calculate these items:

Required Item Result

Net interest income ____
Net noninterest income ____
Pretax net operating income ____
Net income after taxes ____
Total operating revenues ____
Total operating expenses ____
Increase in bank’s undivided profits ____

Question 4) Given Balance Sheet Data

Item Amount
Gross loans 300
Allowance for loan losses 15
Federal funds sold 26
Common stock 12
Surplus 19
Total equity capital 49
Cash and due from banks 9
Miscellaneous assets 38
Bank premises and equipment, gross 34
Trading-account securities 2
Other real estate owned 4
Goodwill and other intangibles 3
Total liabilities 380
Preferred stock 3
Nondeposit borrowings 20
Bank premises and equipment, net 29

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Please calculate these items:

Required Item Result

Total assets ____
Net loans ____
Undivided profits ____
Investment securities ____
Depreciation ____
Total deposits ____

Question 5) The Hokie High Bank has Gross Loans of $550 million with an ALL account of $30 million.
Two years ago the bank made a loan for $10 million to finance the Hokie Hotel. One million in principal was
repaid before the borrowers defaulted on the loan. The Loan Committee at Hokie High Bank believes the
Hotel will sell at auction for $7 million and they want to charge off the remainder immediately.
a) The dollar figure for Net Loans before the charge-off is ______ ?
b) After the charge-off, what are the dollar figures for Gross Loans, ALL, and Net Loans assuming no
other transactions?
c) If the Hokie Hotel sells at auction for $8 million, how will this affect the pertinent balance sheet
accounts?
Question 6) For each of the following transactions, which items on a bank’s statement of income and
expenses (Report of Income) would be affected?
a) Office supplies are purchased so the bank will have enough deposit slips and other necessary forms
for customers and employees use next week.
b) The bank sets aside funds to be contributed through its monthly payroll to the employee pension plan
in the name of all its eligible employees.
c) The bank posts the amount of interest earned on the savings account of one of its customers.
d) Management expects that among a series of real estate loans recently granted the default rate will
probably be close to 3 percent.
e) Mr. and Mrs. Harold Jones just purchased a safety deposit box to hold their stock certificates and
wills.
f) The bank collects $1 million in interest payments from loans it made earlier this year to the
Composition Corp.
g) Hal Jones’ checking account is charged $30 for two of Hal’s checks that were returned for insufficient
funds.
h) The bank earns $5 million in interest on the government securities it has held since the middle of last
year.
i) The bank has to pay its $5,000 monthly utility bill today to the local electric company.
j) A sale of government securities has just netted the bank a $290,000 capital gain (net of taxes).

Question 7) For each of the transactions described here, which of at least two accounts on a bank's balance
sheet (Report of Condition) would be affected by each transaction?
a. Sally Mayfield has just opened a time deposit in the amount of $6,000 and these funds are immediately
loaned to Robert Jones to purchase a used car.
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b. Arthur Blode deposits his payroll check for $1,000 in the bank and the bank invests the funds in a
government security.
c. The bank sells a new issue of common stock for $100,000 to investors living in its community and the
proceeds of that sale are spent on the installation of new ATMs.
d. Jane Gavel withdraws her checking account balance of $2,500 from the bank and moves her deposit to a
credit union; the bank employs the funds received from Mr. Alan James, who has just paid off his home equity
loan, to provide Ms. Gavel with the funds she withdrew.
e. The bank purchases a bulldozer from Ace Manufacturing Company for $750,000 and leases it to Cespán
Construction Company.
f. Signet National Bank makes a loan of reserves in the amount of $5 million to Quesan State Bank and the
funds are returned the next day.
g. The bank declares its outstanding loan of $1 million to Deprina Corp. to be uncollectible.

Question 8) Out-of-Sync Bank is developing a list of off-balance sheet items for its call report. Please fill
in the missing items from its statement shown below. Using Table 5–5, describe how Out-of-Sync compares
with other banks in the same size category regarding its off-balance sheet activities.
Off-balance-sheet items for Out-of-Sync Bank (in millions of $)

Item Amount
Total unused commitments 5,000
Standby letters of credit and foreign office guarantees 350
(Amount conveyed to others) -70
Commercial letters of credit 25
Securities lent 1,000
Derivatives (total) 79,000
Notional amount of credit derivatives 2,000
Interest rate contracts ____
Foreign exchange rate contracts 9,000
Contracts on other commodities and equities 1,200
All other off-balance sheet liabilities 49
Total off-balance-sheet items ____
Total assets (on-balance sheet) 8,600
Off-balance-sheet items divided by on-balance sheet assets ____

Question 9) See if you can determine the amount of Rosebush State Bank’s current net income after taxes
from the figures below (stated in millions of dollars) and the amount of its retained earnings from current
income that it will be able to reinvest in the bank. (Be sure to arrange all the figures given in correct sequence
to derive the bank’s Report of Income.)

Item Amount
Effective tax rate 30%
Interest and fees on loans 75

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 Employee wages, salaries, and benefits 13
Interest and dividends earned on government bonds and notes 9
Provision for loan losses 8
Overhead expenses 3
Service charges paid by depositors 5
Security gains 3
Interest paid on federal funds purchased 9
Payment of dividends of $2 per share on 1 million outstanding ____
shares to common stockholders
Interest paid to customers holding time and savings deposits 34
Trust department fees 3

Question 10) Which of these account items or entries would normally occur on a bank’s balance sheet
(Report of Condition) and which on a bank’s income and expense statement (Report of Income)?

Federal funds sold Deposits due to banks

Retained earnings Leases of business equipment to customers
Credit card loans Interest received on credit card loans
Utility expense Employee benefits
Vault cash Savings deposits
Allowance for loan losses Provision for loan losses
Depreciation on plant and equipment Service charges on deposits
Commercial and industrial loans Undivided profits
Repayments of credit card loans Mortgage owed on the bank’s buildings
Common stock Other real estate owned
Interest paid on money market deposits
Securities gains or losses

Question 11) You were informed that the bank’s latest income and expense statement contained the following
figures (in $ millions):

Item Amount
Net interest income 800
Net noninterest income -300
Net income before income taxes 484
Increases in bank’s undivided profits 100
Suppose you also were told that:
• The bank’s total interest income is twice as large as its total interest expense.
• Its noninterest income is three-fourths of its noninterest expense.
• Provision for loan losses equals 1 percent of its total interest income.
• Taxes generally amount to 30 percent of its net income before income taxes.
Calculate the following items for this bank’s income and expense statement:
Total interest income
Total interest expenses
Total noninterest income

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 Total noninterest expenses
Provision for loan losses
Income taxes
Dividends paid to common stockholders

Question 12) Why do the financial statements issued by banks and by nonbank financial-service providers
look increasingly similar today? Which nonbank financial firms have balance sheets and income statements
that closely resemble those of commercial banks (especially community banks)?
Question 13) What principal types of assets and funds sources do nonbank thrifts (including savings banks,
savings and loans, and credit unions) draw upon? Where does the bulk of their revenue come from and what
are their principal expense items?
Question 14) How are the balance sheets and income statements of finance companies, insurers, and
securities firms similar to those of banks, and in what ways are they different? What might explain the
differences you observe?

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2. MEASURING AND EVALUATING THE PERFORMANCE OF BANKS
2.1. Questions:
1) Why should banks be concerned about their level of profitability and exposure to risk?
2) What individuals or groups are likely to be interested in these dimensions of performance for a
commercial bank?
3) What factors influence the stock price of a financial service corporation?
4) Suppose that a bank is expected to pay an annual dividend of $4 per share on its stock in the current
period and dividends are expected to grow 5 percent a year every year and the minimum required
return to equity capital based on the bank’s perceived level of risk is 10 percent. Can you estimate the
current value of the bank’s stock?
5) What is return on equity capital and what aspect of performance is it supposed to measure? Can you
see how this performance measure might be useful to the managers of financial firms?
6) Suppose a bank reports that its net income for the current year is $51 million, its assets total $144
million, and its liability amount to $926 million. What is its return on equity capital? Is the ROE you
have calculated good or bad? What information do you need to answer this last question?
7) What is the return on assets (ROA) and why is it important? Might the ROA measure be important to
a bank’s key competitors?
8) A bank estimates that its total revenues will amount to $155 million and its total expenses including
taxes will equal $107 million this year. Its liabilities total $4,960 million while its equity capital
amounts to $52 million. What is the bank’s return on assets? Is this ROA high or low? How could you
find out?
9) Why do the managers of financial firms often pay close attention today to the net interest margin and
noninterest margin? To the earnings spread?
10) Suppose a banker tells you that his bank in the year just completed had total interest expenses on all
portfolios of $12 million and noninterest expenses of $5 million, while interest income from earning
assets totaled $16 million and noninterest revenues totaled $2 million. Suppose further that assets
amounted to $480 million, of which earning assets represented 85 percent of that total, while total
interest-bearing liabilities amounted to 75 percent of total assets. See if you can determine this bank’s
net interest and noninterest margins and its earnings base and earnings spread for the most recent year.
11) What are the principal components of ROE and what does each of these components measure?
12) Suppose a bank has an ROA of 0.80 percent and an equity multiplier of 12x. What is its ROE? Suppose
this bank’s ROA falls to 0.60 percent. What size equity multiplier must it have to hold its ROE
unchanged?
13) Suppose a bank reports net income of $12, pretax net income of $15, operating revenues of $100,
assets of $600, and $50 in equity capital. What is the bank’s ROE? Tax-management efficiency
indicator? Expense control efficiency indicator? Asset management efficiency indicator? Funds
management efficiency indicator?
14) What are the most important components of ROA and what aspects of a financial institution’s
performance do they reflect?
15) If a bank has a net interest margin of 2.50%, a noninterest margin of –1.85%, and a ratio of provision
for loan losses, taxes, security gains, and extraordinary items of –0.47%, what is its ROA?

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 16) To what different kinds of risk are banks and their financial-service competitors subjected today?
17) What items on a bank’s balance sheet and income statement can be used to measure its risk exposure?
To what other financial institutions do these risk measures seem to apply?
18) A bank reports that the total amount of its net loans and leases outstanding is $936 million; its assets
total $1,324 million; its equity capital amounts to $110 million; and it holds $1,150 million in deposits,
all expressed in book value. The estimated market values of the bank’s total assets and equity capital
are $1,443 million and $130 million, respectively. The bank’s stock is currently valued at $60 per share
with annual per-share earnings of $2.50. Uninsured deposits amount to $243 million and money market
borrowings total $132 million, while nonperforming loans currently amount to $43 million and the
bank just charged off $21 million in loans. Calculate as many of the risk measures as you can from the
foregoing data.

2.2. Exercises
1. An investor holds the stock of First National Bank of Imoh and expects to receive a dividend of $12
per share at the end of the year. Stock analysts have recently predicted that the bank’s dividends will
grow at approximately 3 percent a year indefinitely into the future. If this is true, and if the appropriate
risk-adjusted cost of capital (discount rate) for the bank is 15 percent, what should be the current price
per share of Imoh’s stock?
2. Suppose that stockbrokers have projected that Poquoson Bank and Trust Company will pay a dividend
of $3 per share on its common stock at the end of the year; a dividend of $4.50 per share is expected
for the next year, and $6 per share in the following year. The risk-adjusted cost of capital for banks in
Poquoson’s risk class is 17 percent. If an investor holding Poquoson’s stock plans to hold that stock
for only three years and hopes to sell it at a price of $55 per share, what should the value of the bank’s
stock be in today’s market?
3. Depositors Savings Association has a ratio of equity capital to total assets of 7.5 percent. In contrast,
Newton Savings reports an equity-capital-to-asset ratio of 6 percent.
What is the value of the equity multiplier for each of these institutions? Suppose that both institutions
have an ROA of 0.85 percent. What must each institution’s return on equity capital be? What do your
calculations tell you about the benefits of having as little equity capital as regulations or the
marketplace will allow?

4. The latest report of condition and income and expense statement for Galloping Merchants National
Bank are as shown in the following tables:
Income Statement

Income and Expense Statement Value

Interest & fees on loans 65
Interest & dividends on securities 12
Total interest income 97
Interest on deposits 49
Interest on borrowings 6
Total interest expense
Net interest income
Provision for loan losses 2

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 Noninterest income 7
Noninterest Expenses
Salaries & benefits 12
Overhead 5
Other expenses 3
Total
Pretax operating income
Securities gains 1
Pretax net income
Taxes 1
Net operating income
Extraordinary items -1
Net income

Balance Sheet

Assets Value Liabilities

Cash & due from banks 100 Demand deposits 190
Investment securities 150 Savings deposits 180
Federal funds sold 10 Time deposits 470
Net loans 670 Federal funds purchased 60
Allowance for loan loss (=25) Total liabilities 900
Unearned income on loans (=5) Equity capital
Plant & equipment 50 Common stock 20
Total assets 980 Surplus 25
Retained earnings 35
Total capital 80
Earning assets 830 Interest-bearing deposits 630

Calculate the following performance measures:

ROE Asset utilization

ROA Equity multiplier
Net interest margin Tax management efficiency
Net noninterest margin Expense control efficiency
Net operating margin Asset management efficiency
Net profit margin Funds management efficiency
Earnings spread Operating efficiency ratio

What strengths and weaknesses are you able to detect in Galloping Merchants’ performance?

5. The following information is for Shallow National Bank:

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Item Value
Interest income 2,100
Interest expense 1,400
Total assets 30,000
Securities gains/losses 21
Earning assets 25,000
Total liabilities 27,000
Taxes 16
Shares of common stock outstanding 5,000
Noninterest income 700
Noninterest expense 900
Provision for Loan losses 100

Please calculate:
ROE
ROA
Net interest margin
Earnings per share
Net noninterest margin
Net operating margin
Alternative scenarios:
a) Suppose interest income, interest expenses, noninterest income, and noninterest expenses each
increase by 5 percent while all other revenue and expense items shown in the preceding table remain
unchanged. What will happen to Shallow’s ROE, ROA, and earnings per share?
b) On the other hand, suppose Shallow’s interest income and expenses as well as its noninterest income
and expenses decline by 5 percent, again with all other factors held constant. How would the bank’s
ROE, ROA, and per-share earnings change?
6. Blue and White National Bank holds total assets of $1.69 billion and equity capital of $139 million
and has just posted an ROA of 1.10 percent. What is the bank’s ROE?
Alternative scenarios:
a) Suppose Blue and White finds its ROA climbing by 50 percent, with assets and equity capital
unchanged. What will happen to its ROE? Why?
b) On the other hand, suppose the bank’s ROA drops by 50 percent. If total assets and equity capital
hold their constant positions, what change will occur in ROE?
c) If ROA at Blue and White National Bank remains fixed at 0.0076 but both total assets and equity
double, how does ROE change? Why?
d) How would a decline in total assets and equity by half (with ROA still at 0.0076) affect the bank’s
ROE?

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 7. Monarch State Bank reports total operating revenues of $135 million, with total operating expenses of
$121 million, and owes taxes of $2 million. It has total assets of $1.00 billion and total liabilities of
$900 million. What is the bank’s ROE?
Alternative scenarios:
a. How will the ROE for Monarch State Bank change if total operating expenses, taxes, and total operating
revenues each grow by 10 percent while assets and liabilities remain fixed?
b. Suppose Monarch State’s total assets and total liabilities increase by 10 percent, but its revenues and
expenses (including taxes) are unchanged. How will the bank’s ROE change?
c. Can you determine what will happen to ROE if both operating revenues and expenses (including taxes)
decline by 10 percent, with the bank’s total assets and liabilities held constant?
d. What does ROE become if Monarch State’s assets and liabilities decrease by 10 percent, while its operating
revenues, taxes, and operating expenses do not change?
8. Suppose a stockholder-owned thrift institution is projected to achieve a 1.25 percent ROA during the
coming year. What must its ratio of total assets to equity capital be if it is to achieve its target ROE of
12 percent? If ROA unexpectedly falls to 0.75 percent, what assets-to-capital ratio must it then have
to reach a 12 percent ROE?
9. Saylor County National Bank presents us with these figures for the year just concluded. Please
determine the net profit margin, equity multiplier, asset utilization ratio, and ROE.
Net income: $18.00
Total operating revenues: 125.00
Total assets: 1,500.00
Total equity capital accounts: 155.00

10. Lochiel Commonwealth Bank and Trust Company has experienced the following trends over the past
five years (all figures in millions of dollars):

Year Net Income After-Tax Total Operating Revenues Total Assets Total Equity Capital

1 2.70 26.50 293.00 18.00

2 3.50 30.10 332.00 20.00

3 4.10 39.80 474.00 22.00

4 4.80 47.50 508.00 25.00

5 5.70 55.90 599.00 28.00

Determine the figures for ROE, profit margin, asset utilization, and equity multiplier for this bank. Are any
adverse trends evident? Where would you recommend that the bank’s emerging problem(s)?

11. Wilmington Hills State Bank has just submitted its Report of Condition and Report of Income to its
principal supervisory agency. The bank reported net income before taxes and securities transactions of
$27 million and taxes of $6 million. If its total operating revenues were $780 million, its total assets
$2.1 billion, and its equity capital $125 million, determine the following for Wilmington:
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a. Tax management efficiency ratio.
b. Expense control efficiency ratio.
c. Asset management efficiency ratio.
d. Funds management efficiency ratio.
e. ROE.
Alternative scenarios:
a. Suppose Wilmington Hills State Bank experienced a 20 percent rise in net before-tax income, with its tax
obligation, operating revenues, assets, and equity unchanged. What would happen to ROE and its components?
b. If total assets climb by 20 percent, what will happen to Wilmington's efficiency ratio and ROE?
c. What effect would a 20 percent higher level of equity capital have upon Wilmington's ROE and its
components?
12. Using the information below from the Lochness International Bank and Trust Company (all figures in
millions of USD), calculate the bank's net interest margin, noninterest margin, and ROA.

Khoản mục Giá trị (triệu USD)

Interest income $65
Interest expense 48
Provision for loan losses 3
Security gains or losses 2
Noninterest expense 8
Noninterest income 5
Extraordinary net gains 1
Total assets 986

13. Valley Savings Bank has reported the following figures (in million USD) in its income statements for
the past five years. Calculate the organization's ROA for each year. Are there any unfavorable trends?
Are there any favorable trends? What appears to be happening with this organization?

Khoản mục Current One Year Two years Three years Four years
Year ago ago ago ago
Gross interest income $40 $41 $38 $35 $33
Interest expenses 24 23 20 18 15
Noninterest income 4 4 3 2 1
Noninterest expense 8 7 7 6 5
Provision for loan losses 2 1 1 0 0
Income taxes owed 1 1 0 1 0
Net securities gains/losses -2 -1 0 1 2
Total assets 385 360 331 319 293

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 14. An analysis of NCB's UBPR reports has been presented in this chapter. We have examined several
indicators measuring the bank's profitability, including ROA, ROE, net profit margin, net interest and
operating margin, and asset utilization. However, various measures of income risk, earnings risk,
liquidity risk, market risk (price risk and interest rate risk), and capital risk have not been discussed in
detail.
Using the data in Tables 6-5 to 6-9, calculate each of these risk aspects for NCB for the two most recent years
and discuss how the bank's risk exposure appears to be changing over time. What steps would you suggest to
management to address any risk exposure issues you observe?

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