Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

CHAPTER 5

THE FINANCIAL STATEMENTS OF BANKS AND THEIR PRINCIPAL

COMPETITORS

Problems
5-1. Norfolk 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):

Report of Condition
Total assets $4,000.00
Cash and due from depository institutions 90.00
Securities 535.00
Federal funds sold and reverse repurchase agreements 45.00
Gross loans and leases
Loan loss allowance 200.00
Net loans and leases 2,700.00
Trading account assets 20.00
Bank premises and fixed assets
Other real estate owned 15.00
Goodwill and other intangibles 200.00
All other assets 175.00
Total liabilities and capital
Total liabilities
Total deposits
Federal funds purchased and repurchase agreements. 80.00
Trading liabilities 10.00
Other borrowed funds 50.00
Subordinated debt 480.00
All other liabilities 40.00
Total equity capital
Perpetual preferred stock 5.00
Common stock 25.00
Surplus 320.00
Undivided profits 70.00

Report of Condition
Total assets $4,000.00
Cash and due from depository institutions 90.00
Securities 535.00
Federal funds sold and reverse repurchase agreements 45.00
Gross loans and leases $2,900.00a

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 Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

Loan loss allowance 200.00

Net loans and leases 2,700.00
Trading account assets 20.00
Bank premises and fixed assets 220.00b
Other real estate owned 15.00
Goodwill and other intangibles 200.00
All other assets 175.00
Total liabilities and capital 4,000.00c
Total liabilities 3,580.00d
Total deposits 2,920.00e
Federal funds purchased and repurchase agreements. 80.00
Trading liabilities 10.00
Other borrowed funds 50.00
Subordinated debt 480.00
All other liabilities 40.00
Total equity capital 420.00f
Perpetual preferred stock 5.00
Common stock 25.00
Surplus 320.00
Undivided profits 70.00

a. Gross loans and leases = Net loans and leases + Loan loss allowance
($200.00 + $2,700.00)
b. This is the only asset missing and so it is total assets less all of the rest of the assets listed
above. ($4,000.00 − $90.00 − $535.00 − $45.00 − $2,700.00 − $20.00 − $15.00 −
$200.00 − $175.00)
c. Total liabilities and capital = Total assets ($4,000.00)
d. Total liabilities = Total liabilities and capital − Total equity capital ($4,000.00 − $420.00)
e. Total deposits = Total liabilities − All of the other liabilities ($3,580.00 − $80.00 − $10.00
− $50.00 − $480.00 − $40.00)
f. Total equity capital = Perpetual preferred stock + Common stock + Surplus + Undivided
profit ($5.00 + $25.00 + $320.00 + $70.00)

5-2. Along with the Report of Condition submitted above, Norfolk 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):

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

Report of Income
Total interest income $200
Total interest expense
Net interest income 60
Provision for loan and lease losses
Total noninterest income 100
Fiduciary activities 20
Service charges on deposit accounts 25
Trading account gains and fees
Additional noninterest income 30
Total noninterest expense 125
Salaries and employee benefits
Premises and equipment expense 10
Additional noninterest expense 20
Pretax net operating income 15
Securities gains (losses) 5
Applicable income taxes 3
Income before extraordinary items
Extraordinary gains—net 2
Net income

Report of Income
Total interest income $200
Total interest expense 140a
Net interest income 60
Provision for loan and lease losses 20b
Total noninterest income 100
Fiduciary activities 20
Service charges on deposit accounts 25
Trading account gains and fees 25c
Additional noninterest income 30
Total noninterest expense 125
Salaries and employee benefits 95d
Premises and equipment expense 10
Additional noninterest expense 20
Pretax net operating income 15
Securities gains (losses) 5
Applicable income taxes 3
Income before extraordinary items 17e
Extraordinary gains—net 2
Net income 19f

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

a. Total interest expense = Total interest income − Net interest income ($200 − $60)
b. Provision for loan and lease losses = Net interest income + Total noninterest income −
Total noninterest expense − Pretax net operating income (60 + $100 – $125 – $15)
c. There are four areas of Total noninterest income and only one is missing and the total is
given. ($100 − $20 − $25 − $30)
d. There are three areas of Total noninterest expense and only one is missing and the total is
given ($125 – $10 – $20)
e. Income before extraordinary items = Pretax income + Security gains – Taxes ($15 + $5 –
$3)
f. Net income = Income before extraordinary items + Extraordinary gains—net ($17 + $2)

5-3. If you know the following figures:

Total interest income $140 Provision for loan losses $5

Total interest expenses 100 Income taxes 4
Total noninterest income 75 Increases in bank’s undivided profits 6
Total noninterest expenses 90

Please calculate these items:

Net interest income

Net noninterest income
Pretax net operating income
Net income after taxes
Total operating revenues
Total operating expenses
Dividends paid to common stockholders

Net interest income $40a

Net noninterest income −15b
Pretax net operating income 20c
Net income after taxes 16d
Total operating revenues 215e
Total operating expenses 195f
Dividends paid to common stockholders 10g

a. Total interest income − Total interest expense ($140 − $100)

b. Total noninterest income − Total noninterest expense ($75 − $90)
c. Net interest income + Net noninterest income − PLL ($40 – $15 − $5)
d. Pretax net operating income − Taxes ($20 − $4)
e. Interest income + Noninterest income ($140 + $75)
f. Interest expenses + noninterest expenses + Provision for loan losses ($100 + $90 + $5)

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

g. Net income after taxes − increases in bank’s undivided profits ($16 − $6)

5-4. If you know the following figures:

Gross loans $300 Trading-account securities $2

Allowance for loan losses 15 Other real estate owned 4
Investment securities 36 Goodwill and other intangibles 3
Common stock 5 Total liabilities 375
Surplus 15 Preferred stock 3
Total equity capital 30 Nondeposit borrowings 40
Cash and due from banks 10 Bank premises and equipment, net 20
Miscellaneous assets 25
Bank premises and equipment, gross 25

Please calculate these items:

Total assets
Net loans
Undivided profits
Fed funds sold
Depreciation
Total deposits

Total assets $405a

Net loans $285b
Undivided profit $7c
Fed funds sold $20d
Depreciation $5e
Total deposits $335f

a. Total liabilities + Total equity capital ($30 + $375)

b. Gross loans − Allowance for loan losses ($300 – $15)
c. Total equity capital – Preferred stock – Common stock – Surplus ($30 – $15 – $5 – $3)
d. This is the only asset missing so subtract all other assets from total assets
e. Bank premises and equipment, gross – bank premises and equipment, net ($25 – $20)
f. Total liabilities less nondeposit borrowings ($375 – $40)

5-5. The Sea Level Bank has Gross Loans of $800 million with an ALL account of $45
million. Two years ago the bank made a loan for $12 million to finance the Sunset Hotel. Two
million dollars in principal was repaid before the borrowers defaulted on the loan. The Loan
Committee at Sea Level Bank believes the hotel will sell at auction for $7 million and they want
to charge off the remainder immediately.

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

a. The dollar figure for Net Loans before the charge-off is _____.

Net Loans = Gross Loans –ALL = $800 − $45 = $755 million

b. After the charge-off, what are the dollar figures for Gross Loans, ALL and Net Loans
assuming no other transactions?

Gross Loans = $800 million – ($10 million − $7 million) = $797 million

ALL =$45 million – ($12 million− $2 million − $7 million) = $42 million (The amount of
the loan that is bad)

Net Loans = Gross Loans – ALL = $797 − $42 = $755 million

c. If the Sunset Hotel sells at auction for $10 million, how will this affect the pertinent
balance sheet accounts?

Gross loans and ALL would not change as the bank would recover all the money invested
earlier.

5-7. 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.

Gross loans + $6,000 Total deposits + $6,000

b. Arthur Blode deposits his payroll check for $1,000 in the bank, and the bank invests the
funds in a government security.

Government securities + $1,000 Total deposits + $1,000

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.

Bank premises & equipment, gross + Common stock/surplus + $100,000

$100,000

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.

Gross Loans − $2,500 Total Deposits − $2,500

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

e. The bank purchases a bulldozer from Ace Manufacturing Company for $750,000 and
leases it to Cespan Construction Company.

Cash and Due from Bank − $750,000 Gross Loans and Leases + 750,000

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.

On the day the funds are loaned the accounts are affected in the following manner:
Cash and Due from Bank − $5,000,000 Federal Funds Sold +$5,000,000

When the funds are returned the next day, the process is reversed.

g. The bank declares its outstanding loan of $1 million to Deprina Corp. to be uncollectible.

Gross Loans −$1,000,000 ALL −$1,000,000

5-8. The John Wayne 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
John Wayne compares with other banks in the same size category regarding its off-balance sheet
activities.
Off-balance-sheet items for John Wayne Bank (in millions of $)

Total unused commitments $8,000

Standby letters of credit and foreign office
guarantees 1,350
(Amount conveyed to others) −50
Commercial letters of credit 60
Securities lent 2,200
Derivatives (total) 100,000
Notional amount of credit derivatives 22,000
Interest rate contracts 54,000
Foreign exchange rate contracts
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) $12,000
Off-balance-sheet assets ÷ on-balance-sheet
assets

Off-balance-sheet items for John Wayne Bank (in millions of $)

Total unused commitments $8,000

Standby letters of credit and foreign office 1,350

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

guarantees
(Amount conveyed to others) −50
Commercial letters of credit 60
Securities lent 2,200
Derivatives (total) 100,000
Notional amount of credit derivatives 22,000
Interest rate contracts 54,000

Foreign exchange rate contracts 22,800a

Contracts on other commodities and
equities 1,200
All other off - balance -sheet liabilities 49
Total off-balance-sheet items 111,609b
Total assets (on-balance sheet) 12,000
Off-balance-sheet assets ÷ on-balance-sheet
assets 9.30%

a. Total derivatives − All other derivatives [100,000 – (22,000 + 54,000 + 1200)]

b. The sum of all of the off-balance sheet items

The Off-balance-sheet-assets of John Wayne Bank are in proportion with other banks of the same
size.

5-9. See if you can determine the amount of Bluebird 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.)

Effective tax rate 28%

Interest on loans $90
Employee wages, salaries, and benefits 13
Interest earned on government bonds and notes 9
Provision for loan losses 5
Overhead expenses 3
Service charges paid by depositors 3
Security gains/losses –7
Interest paid on federal funds purchased 5
Payment of dividends of $4 per share on 1
million outstanding shares to be made to
common stockholders
Interest paid to customers holding time and 40
savings deposits
Trust department fees 3
Bluebird State Bank
Report of Income (in millions of dollars)

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

Total interest income

Interest on loans $90
Int earned on government bonds and
notes $9
Total $99

Total interest expense

Interest paid on federal funds purchased $5
Interest paid to customers time and
Savings deposits $40
Total $45

Net interest income $54

Provision for loan loss $5

Total noninterest income

Service charges paid by depositors $3
Trust department fees $3
Total $6

Total noninterest expenses

Employee wages, salaries and benefits $13
Overhead expenses $3
Total $16

Net noninterest income ($10)

Pretax income $39

Taxes paid (28%) $11
Securities gains/(losses) ($7)

Net income $21

Less dividends $4
Retained earnings from current income $17

5-10. 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

Addition to undivided profits Leases of business equipment to customers
Credit card loans Interest received on credit card loans
Utility expense Fed funds purchased
Vault cash Savings deposits
Allowance for loan losses Provision for loan losses
Depreciation on premises and equipment Service charges on deposits

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

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

The items which would normally appear on a bank's balance sheet are:

Federal funds sold Deposits due to bank

Credit card loans Leases of business equipment
to customers
Vault cash Savings deposit
Allowance for loan losses Undivided profits
Commercial and Industrial Mortgage owed on the bank’s
Loans buildings
Repayments of credit card Other real estate owned
loans
Common stock Additions to undivided profits
Federal funds purchased

The items which would normally appear on a bank’s income statement are:

Interest received on credit card Provision for loan losses

loans
Depreciation on premises and Service charges on
equipment deposits
Interest paid on money market
deposits
Securities gains or losses
Utility expense

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Chapter 05 - The Financial Statements of Banks and Their Principal Competitors

5-11 You were informed that a bank’s latest income and expense statement contained the
following figures (in $ millions):

Net interest income $800

Net noninterest income (500)
Pretax net operating income 252
Security gains 100
Increases in bank’s undivided
profits 200

Suppose you also were told that the bank’s total interest income is twice as large as its total
interest expense and its noninterest income is three-fourths of its noninterest expense. Imagine
that its provision for loan losses equals 3 percent of its total interest income, while its 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 (TII) and Total interest expense (TIE):

TII = 2 TIE and Net interest income = TII –TIE = $800 so:
2 TIE – TIE = $800
Hence, TIE = $800 and TII = 2 ($800) = $1,600

Total noninterest income (TNI) and Total noninterest expense (TNE):

TNI = 0.75TNE and Net noninterest income = TNI – TNE = – $500 so:
0.75TNE – TNE = – $500 therefore, – 0.25 (TNE) = – $500.
Hence, TNE = $2,000 and TNI = 0.75 × ($2,000) = $1,500

Provision for loan losses (PLL):

PLL = 0.03×Total interest income = 0.03 × ($1,600) = $48

Income taxes:
Net income before taxes = Net interest income + Net noninterest income – PLL
Net income before taxes = $800 – $500 – $48 = $252
Taxes = 0.3 × Net income before taxes = 0.3 × 252 = $75.60
Dividends paid to common stockholders:
Net income after taxes = Net income before taxes − Taxes
Net income after taxes = $252 − $75.60 = $176.4
Increase in undivided profit = Net income after taxes – Dividends
Dividends = Net income after taxes – Increase in undivided profit
Dividends= $176.4 − $200 = -$23.6
Therefore, no dividends are paid to common stockholders.

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