Read the Balance Sheet of a Bank
A bank's rest sheet is different from that of a typical company. You won't find inventory, accounts receivable, or accounts payable. Instead, under assets, yous'll see more often than not loans and investments, and on the liabilities side, yous'll encounter deposits and borrowings.
Permit's accept a closer look at the residue sail of the fictional First Banking concern of the Fool.
| 12/31/2006 | % of Assets | |
|---|---|---|
| Avails | ||
| Cash | l | two% |
| Securities | 500 | 22% |
| Loans | 1,500 | 67% |
| Other Assets | 200 | 9% |
| Total Assets | 2,250 | 100% |
| Liabilities & Equity | ||
| Deposits | 1,400 | 62% |
| Borrowings | 600 | 27% |
| Shareholder's Equity | 250 | 11% |
| Total Liabilities and Equity | two,250 | 100% |
Greenbacks
Surprisingly, cash represents simply ii% of avails. That'southward because the depository financial institution wants to put its coin to work earning interest. If the bank simply sticks its cash in a vault and forgets about it, it volition have a hard fourth dimension making a profit. Thus, a banking company keeps about of its money tied upwards in loans and investments, which are chosen "earning assets" in bank-speak because they earn interest.
Image source: Getty Images.
Securities
Banks don't like putting their avails into fixed-income securities, because the yield isn't that great. However, investment-grade securities are liquid, and they accept higher yields than cash, so it's always prudent for a bank to keep securities on hand in case they demand to costless up some liquidity.
If we await at Wells Fargo (NYSE:WFC), SunTrust (NYSE:STI), and M&T Bank (NYSE:MTB), we see that approximately sixteen%, 18%, and 17% of their earning assets are invested in securities. The purpose of holding securities is for the bank to take safe, liquid assets bachelor, then the banks primarily concur Treasuries and agency debt (such as Fannie Mae- or Freddie Mac-issued debt), which yield around the rate of the electric current long-term U.S. Government yield, anywhere from 4%-six%.
Loans
Loans represent the majority of a banking company'due south assets. A bank can typically earn a higher interest charge per unit on loans than on securities, roughly 6%-8%. You can find detailed information virtually the rates earned on loans and investments in the financial statements.
Loans, however, come with run a risk. If the bank makes bad loans to consumers or businesses, the bank will take a hit when those loans aren't repaid.
Because loans are a bank's bread and butter, information technology'due south critical to understand a bank's book of loans. In their 10-Ks, banks characterize their loans in easily readable charts. For example, Yard&T tells us that at the end of its final fiscal twelvemonth, 36.5% of its boilerplate loans were backed past commercial real estate. We also know that of its $14.5 billion in commercial real estate loans outstanding, $4.v billion was in metropolitan New York.
I was in one case interested in Corus Bankshares (NASDAQ:CORS). However, equally of terminal quarter, 94% of its loans were for condo structure and conversions, and 33% of its loans were in Florida. Although I've heard skillful things virtually Corus' management, and the valuation looked compelling, I took a pass -- foreseeing the future of the Florida condo market is outside my circle of competence. Nonetheless, 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 property and equipment, represent only a small fraction of assets. A bank tin generate large revenues with very few hard assets. Compare this to another companies, where found, property, and equipment (PP&Eastward) is a major asset.
| Company | PP&E / Assets |
|---|---|
| SunTrust | 1.0% |
| Home Depot (NYSE:Hd) | 49.viii% |
| Procter & Gamble (NYSE:PG) | 13.seven% |
| Disney (NYSE:DIS) | 28.6% |
Data provided by CapitalIQ, a division of Standard & Poor's.
Assessing assets
A bank's assets are its meal ticket, so information technology's critical for investors to empathise how its assets are invested, how much take a chance they are taking, and how much liquidity the depository financial institution has in securities equally a shield against unforeseen bug. In general, investors should pay attention to asset growth, the composition of assets between cash, securities, and loans, and the composition of the loan volume. As well, investors should note a bank's asset/equity (equity multiplier) ratio, which measures how many times a dollar of equity is leveraged. Every bit of the latest quarter, SunTrust, Wells Fargo, and Corus had equity multiplier ratios of 9.ix, 10.7, and 12.25. Paying attention to these trends is critical to making money in bank stocks.
Now that we've looked at a bank's avails, nosotros besides need to sympathize the other side of the balance sheet -- its liabilities, which are how a bank finances its assets. Check back tomorrow for the whole story.
Banking concern on further Foolishness:
- Acquire about a depository financial institution'southward efficiency ratio.
- Take a closer await at banking concern stocks.
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Fool contributor Emil Lee is an annotator and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates comments, concerns, and complaints. The Motley Fool has a disclosure policy.
Source: https://www.fool.com/investing/general/2007/01/05/understanding-a-banks-balance-sheet.aspx
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