How to Read a Bank's Balance Sheet
A bank'southward residual sheet is unlike from that of a typical company. You won't find inventory, accounts receivable, or accounts payable. Instead, under avails, you'll see mostly loans and investments, and on the liabilities side, y'all'll see deposits and borrowings.
Allow's take a closer await at the balance sheet of the fictional First Depository financial institution of the Fool.
| 12/31/2006 | % of Assets | |
|---|---|---|
| Avails | ||
| Cash | l | 2% |
| Securities | 500 | 22% |
| Loans | 1,500 | 67% |
| Other Assets | 200 | 9% |
| Total Avails | two,250 | 100% |
| Liabilities & Equity | ||
| Deposits | 1,400 | 62% |
| Borrowings | 600 | 27% |
| Shareholder's Disinterestedness | 250 | 11% |
| Total Liabilities and Disinterestedness | 2,250 | 100% |
Cash
Surprisingly, cash represents only 2% of avails. That'south because the bank wants to put its money to work earning involvement. If the bank simply sticks its cash in a vault and forgets well-nigh it, it volition take a hard time making a profit. Thus, a bank keeps most of its money tied up in loans and investments, which are called "earning avails" in banking concern-speak because they earn involvement.
Image source: Getty Images.
Securities
Banks don't similar putting their assets into stock-still-income securities, because the yield isn't that great. However, investment-grade securities are liquid, and they have higher yields than greenbacks, and so information technology's always prudent for a bank to keep securities on mitt in case they demand to free upwardly some liquidity.
If we look at Wells Fargo (NYSE:WFC), SunTrust (NYSE:STI), and Chiliad&T Bank (NYSE:MTB), we see that approximately 16%, 18%, and 17% of their earning avails are invested in securities. The purpose of holding securities is for the bank to have prophylactic, liquid assets bachelor, and then the banks primarily agree Treasuries and agency debt (such as Fannie Mae- or Freddie Mac-issued debt), which yield around the charge per unit of the electric current long-term U.Due south. Government yield, anywhere from 4%-6%.
Loans
Loans correspond the majority of a bank'southward avails. A bank tin can typically earn a college interest rate on loans than on securities, roughly 6%-viii%. Yous tin notice detailed information about the rates earned on loans and investments in the financial statements.
Loans, however, come with risk. If the banking concern makes bad loans to consumers or businesses, the bank will take a hitting when those loans aren't repaid.
Because loans are a depository financial institution's bread and butter, it's critical to empathise a bank's book of loans. In their ten-Ks, banks characterize their loans in hands readable charts. For example, K&T tells us that at the terminate of its last fiscal yr, 36.5% of its average loans were backed by commercial real estate. Nosotros also know that of its $xiv.5 billion in commercial real manor loans outstanding, $4.5 billion was in metropolitan New York.
I was once interested in Corus Bankshares (NASDAQ:CORS). However, equally of last quarter, 94% of its loans were for condo structure and conversions, and 33% of its loans were in Florida. Although I've heard adept things about Corus' management, and the valuation looked compelling, I took a laissez passer -- foreseeing the future of the Florida condo marketplace is outside my circle of competence. Yet, bank stock investors have to read the financials if they desire to know the kind of risks to which they are exposed.
Other assets
Other assets, including belongings and equipment, represent only a pocket-sized fraction of assets. A banking concern tin generate large revenues with very few hard assets. Compare this to some other companies, where plant, property, and equipment (PP&East) is a major asset.
| Company | PP&Eastward / Assets |
|---|---|
| SunTrust | 1.0% |
| Home Depot (NYSE:Hard disk drive) | 49.8% |
| Procter & Gamble (NYSE:PG) | 13.7% |
| Disney (NYSE:DIS) | 28.half-dozen% |
Information provided by CapitalIQ, a division of Standard & Poor's.
Assessing assets
A bank'south assets are its meal ticket, so it'due south disquisitional for investors to empathise how its assets are invested, how much risk they are taking, and how much liquidity the banking company has in securities as a shield against unforeseen problems. In general, investors should pay attention to asset growth, the composition of assets between cash, securities, and loans, and the composition of the loan book. Likewise, investors should note a bank's nugget/equity (equity multiplier) ratio, which measures how many times a dollar of equity is leveraged. As of the latest quarter, SunTrust, Wells Fargo, and Corus had equity multiplier ratios of 9.9, 10.7, and 12.25. Paying attention to these trends is disquisitional to making coin in bank stocks.
Now that we've looked at a bank's assets, nosotros also need to understand the other side of the balance sheet -- its liabilities, which are how a banking concern finances its assets. Check back tomorrow for the whole story.
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- Take a closer look at bank stocks.
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Source: https://www.fool.com/investing/general/2007/01/05/understanding-a-banks-balance-sheet.aspx
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