Pro Forma Financial Statements Creator - PowerPoint

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					                       Boston College
                         Fall 2007
                   Management of Financial

                             07-1 & 07-2
                         Prof. Edward J. Kane
Edward Kane, BC 07-1&2
  Course Policy: Although Unfashionable and
   Troublesome, Students Must Earn Grades

    (letters of          (teacher ratings)   (need to offer rewards
recommendation)                              for good performance)
Edward Kane, BC 07-1&2
            Annoying Feature of Course
                                   THE HERBAL
                                    TEA STORE?
                                   YES, THAT’S
                                      ON THE
                                   FLOOR. BUT
                                     FIRST LET
                                    ME EXPLAIN
                                     HOW THEY
                                   PROFITS AND
                                    THEIR RISK.

Edward Kane, BC 07-1&2
       Broad Questions Addressed in First
                Three Weeks
     • What is a financial institution?
     • What do financial institutions do?
     • How do the business plans and charters of principal
       categories of financial institutions differ?
     • How differences in explicit charter powers influence
       information processing, organizational & contractual
       forms, and deal structures?
     • How can institutions create value (i.e., earn a net “total
       return”) doing and supporting deals?
     • How can they abuse accounting leeway to deceive
       creditors, investors, and regulators?

Edward Kane, BC 07-1&2
         1. What is a financial institution?
     Definition: An organization that creates “economic
       value” by producing funds-management,
       informational and transactional products for a
       targeted base of consumers with whom it hopes to
       maintain a longstanding relationship.

    • Each product is a deal that is usually embodied in a contract:
    • Offering products entails risk-taking that requires confidence
      building and risk management
    • FSF-Customer Relationship: Trust established by chain of
      mutually beneficial transactions

Edward Kane, BC 07-1&2
   How Do the Following Institutions Fit
            This Definition?
     • A bank?
     • A mutual fund?

Edward Kane, BC 07-1&2
           Two Core Activities Draw Most
               Customers to an FSF:
     • Funding Opportunities: Equity positions,
       credit lines, loans, credit cards, credit
       enhancements, securities underwriting
     • Wealth-Management Services:
       Administering deposits, mutual-fund shares,
     • What is a “Business Plan?” Example of
       simplest FSF “Business Plan.”

Edward Kane, BC 07-1&2
         These activities are featured in the
          Etymology of the word Finance
     •   Etymology: fin-ance (Latin for an “ending”)
     •   Financial Instruments as “stuff”
     •   Internal Finance: Self-Finance
     •   External Finance
           – Direct
           – Indirect

Edward Kane, BC 07-1&2
 Major Types of Financial Institutions
  1.       Depository Institutions
       •      Commercial Banks
       •      Savings Institutions
       •      Credit Unions
  2.       Securities Firms
       •      Mutual Funds
       •      Brokerages (traditional vs. online)
       •      Investment Bankers
       •      Mortgage Companies
  3.       Insurance and Pensions Firms
  4.       Miscellaneous Institutions
       •      Finance Companies
       •      Venture-Capital Firms
       •      Hedge Funds
  [Related Concepts: Charters, Signature Contracts, Holding-
       Company Conglomerates]                                  9
Edward Kane, BC 07-1&2
        Some of Biggest U.S. Financial
         Institutions by Charter Type
              Banking Org. =    Citigroup
              Insurance Co. =   Prudential
              Mutual Fund Co. = Fidelity, Vanguard
              Thrift Institution = Washington Mutual
              Credit Union =    Navy Credit Union
              Finance Co. =     GE Capital; GMAC
              Brokerage Firm = Merill Lynch; Solomon Smith Barney
              Foreign FSF =     Deutsche Bank
              Hedge Fund =      Kohlberg, Kravis and Roberts

     Query: In what ways do these firms compete with one another?
Edward Kane, BC 07-1&2
    For Banks and Competing Financial Institutions,
    three Institutional Capacities are needed to
    offer instruments in an efficient manner:
    • Information Management: Collecting,
    Verifying, Storing, Analyzing , Moving data.
    • Deal-Making and Portfolio-Management
    Skills: Risk Assessment, Risk Pricing, Risk
    Transfer, Risk Support
    • Network Access: For processing checks and
    electronic transfers; for Trading Securities &
    Complex Claims
Edward Kane, BC 07-1&2
           One Cannot Magically Acquire These Capacities

                         Money Matters         by Mick Stevens

                         “KISS ME AND I’LL TURN INTO A BANKER”

Edward Kane, BC 07-1&2
 Megacept #1
    Accounting Statements & Concepts are Managerial Tools for
      Tracking Deals and their Outcomes
    • Income Statement
          Lists categories of revenues and costs
          Leeway from Nonrecurring Items and other Recognition Options
          Calculates difference as Net Income = Bottom Line

    • Balance Sheet
          Book values of both sides of all deals and also books all hedges

    • Deals
          Every financial instrument may be conceived as a two-sided deal that
           establishes positions for the institution and its customers, positions that create
           value and generate risk.
Edward Kane, BC 07-1&2
           Two Tri-Sectored Double-Entry Accounting
           Statements Help FSF Managers Track Their
              Positions and Performance Over Time
     1.     Income Statement: Tracks FSF performance during a
            designated “accounting period”: May be constructed
            either on a “cash-flow” basis or on an accrual basis.

                         Revenues        Costs
                                         Net Income (profit)

     2.     Balance Sheet: Records position values at a given
           Asset                     Liabilities
                                     Net Worth (= ownership claims)
Edward Kane, BC 07-1&2
What are Itemization and Valuation Rules?
     • Itemization concerns what positions may and may
       not be entered and where to enter them.
     • Valuation concerns how the worth of individual
       items is to be calculated.
     Who Establishes These Rules for U.S. GAAP
      and GAAS?
     • Acronyms: FASB; PCAOB; IASB
     • Specialized FSF SROs and Government
       Regulators in Individual Countries and
       International Coordinating Bodies

Edward Kane, BC 07-1&2
    • Leeway: Alternate valuation schemes [historical
      cost vs. model-generated “fair value” vs. market
      value; accrual vs. cash accounting]
          Alternate itemization schemes [on-balance-
      sheet and off-balance-sheet items; adjustments for
      nonrecurring items]
    • Links exist between income statement and balance

                         Net Income
                 •ROA = Total Assets 1.3+% for banks in 2004
                 •ROE (Leveraged ROA) = ROA x           = 14.2+%
                                               Net Worth
Edward Kane, BC 07-1&2
                 ACCOUNTING FOR DEALS
    1. Every Deal an FSF Makes Establishes: an incremental
       balance sheet, incremental income projections, and
       incremental ROA and ROE for all parties.
         •    Fee for promise of service is cleanest and least-
              interesting example
    2. Accounting for a bank’s one-year loan in cash of $100K at 8
       percent per annum is more complicated.
         •    How the loan is financed and possibly hedged completes
              the deal. The need to fund the loan establishes a tangible
              liability position on the bank’s incremental balance sheet
              and projected funding, servicing, and risk-management
              expense on the income statement for the bank.

Edward Kane, BC 07-1&2
Today’s Incremental Balance Sheet                   Projected Income Statement

Loan      ($108 - costs)/(1+R)            Loan Revenue   $8 Funding costs          ?

Cash                      -$100                             Servicing costs        ?

Loan-Loss Reserves          -$1   N.W.?                     Risk-Management Costs?

           R = Cost of Equity
           Query: What incremental balance sheets might
           emerge at maturity?

 Edward Kane, BC 07-1&2
          Economic Value of Tangible Items is
          Easier to Track Than Intangible Ones
     1.     Tangible Asset: A position created by ownership of
            something that has an actual “physical existence,” such as
            loans, securities, or real estate. The owner of a tangible asset
            can transfer it to another party separately from other claims
            with which the asset might be associated. [Etymology: why
            same as tango dancing?]
     2.     Intangible Asset: A position that either has value only because
            of its connection with a “going concern” or is a right
            conferred by a government or corporation. Intangibles cannot
            be freely or separately traded.

     Exercise: Which of the following values are intangible positions?
          FSF charter, customer base, deposit balances, locations,
          mortgage loans, leasehold, patent, political clout, reputation.

Edward Kane, BC 07-1&2
    Modifying Reported Balance Sheets to Account for
      Economic Value of Asset and Liabilities is the
              Central Problem of the Course.
   Economic Balance Sheet: Comprehensive Itemization and Market Valuation
              Tangible Assets                                     Tangible Liabilities
              Intangible Assets                                   Intangible Liabilities
                                                                  Net Worth (estimates “market cap”)
  GAAP Balance Sheet: Incomplete Itemization at Values Authorized by FASB
              Tangible Assets                                     Tangible Liabilities

              Recognized Intangible Assets                        Recognized Intangible Liabilities
(some footnote disclosures about “off-balance-sheet” positions)   GAAP Net Worth
  Edward Kane, BC 07-1&2
Along with GAAP Balance Sheet, FSF
 Managers Must Manage Intangible
  Variables That Are Not Itemized
      • Six Profit Generators
            –   Reputation
            –   Customer base: Seven Keys
            –   Strategy of Product-Line Management
            –   Management Team
            –   Enterprise Expertise to perform Desirable Services at Low Cost
            –   Political Clout
      • Three Profit Killers
         Competition
            – Government Regulatory Burdens
            – Government tax Burdens                                             21
Edward Kane, BC 07-1&2
          Accounting Net Worth of Tangible
         Balance Sheet Can be Manipulated by
          using Leeway Allowed by GAAP
     1. “Trading book” consists of items in the FSF’s trading
         portfolio that are allegedly marked-to market each day.
     2. Holdings Designated as “Available for Sale.”
     3. “Banking book” consists of business held to maturity. It
         is subject to historical-cost valuation; managers can
         distort timing via: unrealistic loss-reserving; transferring
         securities with unbooked gains to the trading book;
         accrual accounting for revenues and expenses; and using
         deceptive accounting principles for losses in hedging

Edward Kane, BC 07-1&2
   Leeway in Reporting of Accounting Nos. and in
    Shading Service Quality Means that Financial
 Institutions are Complex, Opaque, and People Dare
           Not Trust the Data They Report

Edward Kane, BC 07-1&2
   Leeway in Constructing (or Auditing) an Income
         Statement for FSF Business Plans

     1. Different principles for recognizing the
       timing of:
                • receipt of a revenue or gain
                • incurrence of an expense, loss, or loss exposure
     2. Different ways of categorizing and
       allocating revenues and expenses can
       misrepresent roots of profit or loss.
                • Explicit interest on loans and deposits is
                • Implicit interest on loans and deposits is not.    24
Edward Kane, BC 07-1&2
    • Dedicated loan-loss reserves (LLR) are a
      “contra-asset” that reduces the on-balance-
      sheet value of bank loans. When repayment
      prospects fall, LLR should rise, reducing
      bank capital.
    • Risk is not directly reported in standard
      accounting statements. Contra-assets are
      merely an indirect and discretionary way
      to “risk-adjust” a balance sheet.
    • Text develops a direct measure it calls risk-
      adjusted return on capital (RAROC)
Edward Kane, BC 07-1&2
     Unethical CEOs typically ask Accountants
        to Help Hide Adverse Information

Edward Kane, BC 07-1&2
  it shows
  they have a
  firm grasp
  on how the

Edward Kane, BC 07-1&2
      Conflicts of interest exist in how some of the Top 25 Banks paid
                           their accountants in 2001

                                 From 1-13-02 American Banker     28
Edward Kane, BC 07-1&2
•    Wall Street Journal- March 14, 2006
•    .Fannie Mae Unearths More Accounting Problems: Company Expects to Meet Its Capital Requirements; Market Share
     Drops Again
     March 14, 2006; Page A3

•    Fannie Mae disclosed still more accounting problems and reported a further decline in its share of the U.S. mortgage market.
•    The government-sponsored provider of funds for home mortgages didn't provide an estimate of the financial impact of the latest
     problems. But Fannie said that -- based on its current "view" of its accounting errors -- the company believes it still meets its
     minimum capital requirements. Fannie Mae's regulator, the Office of Federal Housing Enterprise Oversight, raised those capital
     requirements 30% in the wake of an accounting scandal that erupted in 2004.
•    The new problems include improper accounting for certain investment securities and for some of the fees and obligations that
     arise from Fannie's guarantees of payments on mortgages bundled into securities and sold to investors world-wide. The newly
     disclosed problems also relate to accounting for the costs of dealing with houses acquired through foreclosures, for debt
     restructurings and for interest on delinquent loans, among other things.
•    The latest errors come on top of more than a dozen violations of accounting rules already identified by regulators, a team of
     outside lawyers and Fannie executives. The company is working on a restatement of results for the past several years and
     reiterated that it doesn't expect to provide results for 2004 before this year's second half. As part of that restatement, Fannie has
     estimated that it will have to book $10.8 billion of losses on derivatives used to hedge against interest-rate risks. Those losses will
     have to be recognized for the years when they occurred rather than over several years, as was the case under former policies at the
•    Fannie estimated that its share of the U.S. market for issuing new mortgage-related securities fell to 24% in 2005 from 29% in
     2004 and 45% in 2003. Investment banks and large mortgage lenders have grabbed much of that share by taking the lead in
     creating mortgage securities out of subprime loans, which are those for people with flawed credit records, and so-called Alt-A
     loans, which fall slightly short of prime status, often because the borrower's income or assets haven't been fully documented. But
     Fannie said it hopes to play a bigger role in the subprime market and is working on ways to share risks on subprime mortgage
     securities with other investors.
•    Fannie also hopes to regain market share as rising interest rates prompt more people to refinance from adjustable-rate mortgages
     to fixed-rate loans.
•    Cleaning up the books and dealing with investigations and shareholder suits is proving costly. Administrative expenses totaled
     $2.18 billion last year, up 44% from 2004. In a conference call, Fannie executives said they are spending about $50 million a
     month on consultants and other outside experts helping with the restatement and related accounting and corporate-governance
•    Fannie lowered its estimate of its after-tax losses from last year's hurricanes Katrina and Rita to a range of $250 million to $400
     million. Previously, Fannie estimated that the storms could result in losses for the company of as much as $550 million.
•    Daniel Mudd, Fannie's chief executive, said in the conference call that the company expects home sales to decline 8% this year
     and home prices to rise an average of 3%, down from the double-digit pace of recent years. In some of the housing markets that
     have been hottest, "we could see some price declines," Mr. Mudd said.                                                       29
    Edward Kane, BC 07-1&2
                         “We’ve been taking a little harder look at accountants lately.”
Edward Kane, BC 07-1&2
Edward Kane, BC 07-1&2
  Signs that you May Be Interviewing
        with an Unethical Bank
   10. When customers make a deposit, tellers high-five each other.
   9. After customers get a free toaster, bank president begs them for toast.
   8. Monthly statements are scribbled in crayon.
   7. When customers want to make a withdrawal, clerks suddenly don’t
      speak English.
   6. You notice homeless people sleeping in bank vault.
   5. Safe-deposit boxes are Dunkin’ Donuts cartons wrapped in tin foil.
   4. All cash deposits go directly into teller’s pockets.
   3. Lobby is waist-deep in old Iraqi currency.
   2. Toll-free customer-service line is 1-800-GET-HOSED.
   1. Bank President and Board Chairman starred in Jackass: The Movie
    Adapted from 3-7-95 Late Show With David Letterman                  32
Edward Kane, BC 07-1&2
Definitions are Important: Professionals Know
the Names and Tools used in Their Profession

Edward Kane, BC 07-1&2
                         Megacept #2A:
                         What is Interest?

         What is the difference between
         explicit and implicit payments
                   and receipts?
Edward Kane, BC 07-1&2
      Financial intermediaries aim to make a
       profit by borrowing and lending at the same
       time; seek to exploit a wedge between
       lending interest rate and their all-in cost of
       funding direct securities.
      Profitability requires an equilibrium
       “wedge” or “margin” between an
       institution’s lending interest rate and its
       funding cost. Both the lending rate and
       funding interest rate must count all implicit
       and explicit elements.

Edward Kane, BC 07-1&2
    Concept of implicit interest is important. It covers
      all compensation paid to a creditor that the
      contract does not expressly label as interest. A
      June 3, 1996 Supreme Court decision (Smiley vs
      Citibank) determined that the following credit-
      card expenses qualify legally as “interest”:
      membership fees; late-payment penalties;
      insufficient-fund charges; cash-advance fees;
      penalties for exceeding credit limits. Additional
      forms of implicit interest are not even collected in
      the “coin of the realm.” E.g., when a borrower is
      asked to post collateral or hold its deposit accounts
      in the bank.

Edward Kane, BC 07-1&2
   Non-interest activities more important in
            U.S. Banking Industry

                  Noninterest Income as % of Operating Revenues





Edward Kane, BC 07-1&2
                   Megacept #2B: What is
     • Not just data (data are “dumb”)
     • Data must be verified before they deserve to
       be analyzed or responded to
     • Example of Information use by a thermostat

Edward Kane, BC 07-1&2
                Information Production in
           Input          Processing        Output

    Accounting and                           Salient
      Other Data                          information
    Disclosed by or                       on the value
    Extracted from                        of actual and
                         and Valuation
       Bank and                             potential
      Borrowers                             financial

Edward Kane, BC 07-1&2
       What does an FSF do with Information?
     • Collect it
     • Test and Verify it
     • Analyze it (Re-test and Re-verify)
     • Store it (“Data Warehouse”)
     • Move it Over Transactional and Trading Networks
        – for own account
        – for customer accounts
     • Use it to Trigger Actions: guidance, risk
       management, pricing, trading, enforcement, credit
       rating, reserving.

Edward Kane, BC 07-1&2
                  Megacept #3:
    Deals Must be Tied Down by Informational
    Due Diligence at Both Front and Back End

Edward Kane, BC 07-1&2
      Bank-Customer Information Exchange
 1. Predeal: Bank attempts to sell itself to a base of potential
     customers: financial disclosures; marketing efforts touting
     its servicing quality and capacities.
 2. During Dealmaking Negotiation Phase
      – Customer tries to sell itself to the bank. It discloses data on
        income, business and spending plans, character, resources, and
        potential collateral.
      – Both sides try to test and verify information before processing it to
        price and strike a deal.
 3. Continual Post-Deal Monitoring to Look for:
      – Material changes in data supporting both sides of the deal.
      – Ways to improve the deal.
      – Both sides search for better offers from other dealmakers.       42
Edward Kane, BC 07-1&2
  Summary of Concerns in Deal-Making
    • Pre-Deal Information Flows: “Due Diligence”
    • Negotiations and Contracting Adjustments
    • Funding the “obligation” and supporting deal risk
      with “ownership capital”
    • Post-Deal Monitoring of Value and Opportunities
    • Responding to Competitive Pressure
         – From Identically Chartered Institutions
              • In-Market
              • Out of Market: Within U.S. vs. Offshore
         – From Differently Chartered Institutions
         – From Customers seeking better deal designs     43
Edward Kane, BC 07-1&2
      Management’s trick in dealmaking is
      to make the positions beneficial for
              all counterparties.
    • No manager should sign off on a deal
    without figuring out the stakes of every
    party to the transaction.
    • Managers of Financial Services Firms
    (FSFs) have an ethical “obligation” to
    stockholders to worry about possible frauds
    and hidden agendas.
Edward Kane, BC 07-1&2
               Megacept #4: Varieties of
                  Financial Deals
• Interpersonal Loan Contracts = “Direct Finance”
• Pure Brokerage
• Pure Intermediation: “Indirect Finance”
• Credit Enhancement
• Selling Securitized or Unsecuritized Participations
  in Deals or Asset Pools
• Forward-Dated Commitments and Options
• Equity Investment (venture capital, limited
  partnerships, hedge funds)                     45
Edward Kane, BC 07-1&2
                         Diagramming Dealmaking:

  a. Direct Finance Without Outside Credit Enhancement

           Spending                    Funds                  “Deficit
             Units”                                       Spending Units”
         (e.g., savings                                     (e.g., home
                               Info + Securities (i.e.,
           for child’s        evidences of contractual
             college                obligations)

  What information is exchanged? What deal-making occurs?
  Who bears risk of nonperformance?
Edward Kane, BC 07-1&2
     b. Pure Brokerage of Direct Finance

                                      Broker Uses Funds(less fee)
     Surplus                          Expertise to                 Deficit
    Spending                                                      Spending
                                       Help Each
      Units                                                         Units
                         Securities   Side Search   Securities
                          (& Info)        and        (& Info)

Edward Kane, BC 07-1&2
     c. Classic Indirect Finance = Intermediation

                                                             Funds, Info**
                   Funds (& Info*)                           & Monitoring

     Surplus                                                                   Deficit
                                          Financial                           Spending
    Spending              Indirect                             Direct
                                       Intermediaries                           Units
      Units              Securities                           Securities
                         (& Info†)                             (& Info*)

           * about self and needs (pre deal and post deal)
           ** about loan, terms, capital, services, etc.
           † about return and reputation for safety and quality of postdeal service
Edward Kane, BC 07-1&2
      Intermediaries do not buy and sell the same
      Three ways in which intermediation differs
       from pure interest-rate arbitrage
           – Earns compensation for predeal and postdeal
             “intermediation services”
           – Requires Funding of assets held.
           – Accepts Exposure of institutional net worth to
             risk of Future Loss in intermediation vs. no loss
             exposure in arbitrage.

Edward Kane, BC 07-1&2
    • Week 1 Exercise explores “flow-through
      accounting” for a simple FSF “business
      plan.” We ask you to run projections of
      future revenues and costs through the
      bank’s current balance sheet to generate pro
      forma earnings.
    • Bank’s three-part business plan is to:
          1. Make Loans (Buy Earning Assets)
          2. Issue Deposits (Fund Assets)
          3. Hold enough “capital” and
             “liquid assets” to fund and
             support the risk in these services.
Edward Kane, BC 07-1&2
   Goal is to Bring Out Sources and Effects of
 Leeway in Constructing a GAAP Balance Sheet
      Even for this Simple Business Plan
 Different Itemization Principles
 • Contra-assets vs. Contra-revenues: different ways of entering “chargeoffs”
    and benchmarking loss reserves
 • Tangible Assets (timing issues)
 • Intangible Assets
               – Only some are identified (= explicitly recognized on balance
 • Off-balance sheet positions (e.g., credit enhancements; subsidiaries; some
    hedges; Others may be mentioned in footnotes)
 Different Valuation Principles
 • Historical Cost (Banking Book)
 • Market Value (Trading Book)
               – Formal Appraisals using designated comparables
               – Fair-Value Calculations using models
Edward Kane, BC 07-1&2
                             FIRST EXERCISE

    Exemplar Bank reports that it holds $70 billion in (one-year) loans, $20 billion in
        Marketable Securities, and $10 billion in cash and Federal Reserve deposits. On the
        liability side of its accounts, it reports $95 billion in customer deposits.

    1. Assuming the bank has no enterprise intangibles or nondeposit liabilities, construct the
         bank’s balance sheet and find the bank’s net worth position.
         Assets                                       Liabilities
         Loans ______                       Customer deposits       ______
         Other assets ______                Shareholder Net Worth ______

    2. What would the balance sheet look like if the bank allocated one percent of loan
        balances to an appropriate “Reserve for Loan Losses” and entered this reserve as a

    Loans ______                                       Customer deposits      ______
    (Reserve for Loan Losses _____)
    Other assets ______                                Shareholder Net Worth ______
Edward Kane, BC 07-1&2
        Answer Key for Week 1 Exercise
Exemplar Bank reports that it holds $70 billion in (one-year) loans, $20 billion in Marketable
Securities, and $10 billion in cash and Federal Reserve deposits. On the liability side of its accounts, it
reports $95 billion in customer deposits.

  1. Assuming the bank has no nondeposit liabilities, construct the bank’s balance sheet and find the
     bank’s net worth position.

             Assets                        Liabilities
      Loans __70__              Customer deposits __95__
      Other assets __30__       Shareholder Net Worth __5__

  2. What would the balance sheet look like if the bank allocated one percent of loan balances to
     a “Reserve for Loan Losses” and entered this as a “contra-asset”?

      Loans __70__                         Customer deposits _95__
      (Reserve for Loan Losses _.7__)
      Other assets __30__                  Shareholder Net Worth __4.3__

 Edward Kane, BC 07-1&2
 3. Using the Part 1 balance sheet that inflates NW, construct the bank’s projected
      annual income statement from balance sheet No. 1, using the following
      interest–rate assumptions:
 a. The average contract interest rate on the bank’s loans is 8 percent per annum.
           (Be sure to account for the projected default rate of 1 percent).
 b. The average coupon interest rate on the bank’s marketable securities is 6.5
           percent per annum.
 c. The average explicit interest rate paid on the bank’s deposits is 6 percent per
      Revenues (Net of Chargeoffs)
           Loans             ______
           Securities        ______
           Deposits          ______
           Net Income        ______
 4. How would Projected Costs and Net Income change if an implicit interest rate
           of 1 percent applies to deposits?
      Costs                  ______
      Net Income ______
Edward Kane, BC 07-1&2
3. The bank’s projected annual income statement, using thegiven interest–rate assumptions:
   a. The average contract interest rate on the bank’s loans is8 percent per annum. (Be sure to
      account for the projected default rate of 1 percent).
   b. The average coupon interest rate on the bank’s marketable securities is percent per
   c. The average explicit interest rate paid on the bank’s deposits is percent per annum.

       Loans        $5.6 - $.7(1.08) = $5.6 - .7 – .7(8%) “opportunity loss” = 4.844
       Securities   _1.3_
       Deposits     _5.7__
     Net Income     _.444_

                                                       implicit interest rate of 1 percent
4. How would Projected Costs and Net Income change if an
   applied to deposits?

     Costs      _6.65_
     Net Income _-.506_

Edward Kane, BC 07-1&2
            Are Loan-Loss Reserves Part of
            Accounting Net Worth or Not?

   Different Perspectives Correspond to Support For “Expected” vs.
                        “Unexpected” Losses.
Edward Kane, BC 07-1&2
     More on Balance Sheets: A central
     course theme is the importance of
   reconciling internal (accounting) and
 external (market) ways of measuring the
      value a financial firm is creating

      • We will pay special attention to differences
        between a firm’s stock market
        capitalization (S) and the so-called book
        value of its net worth (NW)
Edward Kane, BC 07-1&2
    Management Team that Controls the FSF’s
      Balance Sheet is Called the ALCO.

     • ALCO: Committee composed of CEO & top
       divisional officers that is responsible for
       enterprisewide profit (i.e., value creation) and
       risk-management decisions at an FSF
     • Theme of Our Course: Deal-making requires risk-
       taking and risk-management

Edward Kane, BC 07-1&2
                Risk Management Includes
     • Risk transfer typically entails buying
       insurance or opening an offsetting position
       (i.e., a “hedge” that is negatively correlated
       with the hedgeable item).
     • In principle, balance-sheet items may be
       sorted into hedgeable positions and

Edward Kane, BC 07-1&2
      ALCO members cannot create value for
stockholders unless the ROE on its activities exceeds
    the cost of equity (COE). COE is defined as the
   equilibrium expected return on the FSF’s shares

 • COE = “opportunity cost” of shareholder funds
   = risk-free rate on bonds + appropriate risk
 • ROE > COE is called the “golden rule for value
   creation.” Why?
Edward Kane, BC 07-1&2
     Megacept #5: Centrality of Risk Support
       Provided by “Ownership Capital”
      • Value of owners’ stake = economic net worth
      • “Shock absorber” protecting creditors’ claims on
      • Period-to-period changes in capital are calculated
        as a “residual,” but with accounting leeway
      • How do each of the following items differ?
            – Cash-flow accounting vs. accrual accounting
            – stock-market capitalization vs. economic value of
              tangible & intangible capital
            – Stockholder-contributed capital vs. government-
              contributed capital (= Capitalized value of any
Edward Kane, BC 07-1&2
                    CAPITAL AND RISK
1. Equity capital account absorbs gains and losses
2. Risk entails downside exposure to injury.
3. Managing Nexus of Enterprise-Wide Risk is
  Central to FSF Upside Value-Creation Strategies:
4. Risk Management entails:
    a. Analyzing, pricing, and diversifying risks;
    b. Avoiding uncompensated risks;
    c. Supporting risk-taking with ownership capital
    • Not the same thing as meeting government-enforced
      standards of “safety and soundness.”
Edward Kane, BC 07-1&2
    Alternative Perspective on What a Financial
   Institution (FSF) Is: An information and deal-
   making factory that produces changes in ENW
     • Charters
     • Contracts and Services for Targeted Customers:
       funds management, information, transactions
     • Relationship Building
     • Risk Management: pricing, diversification, capital
     • Coordination: arrangements that tie competing
       FSFs together into cooperative trading, clearing,
       and settlement networks

Edward Kane, BC 07-1&2
                 Tasks are not Changed by
                Globalization of Deal Making
                                    Countries B with most
                                    efficient and safest banks
                                    in world or region (can
                                    credibly offer high risk-
                                    adjusted deposit rates to A
                                    and attractive lending
                                    rates to C

    Bank funding available at                                     Lending profits available in
    relatively low deposit                                        Countries C from financing
    interest rates from savers in                                 promising, but risky
    the world’s high-saving                                       investment projects
    countries A

Edward Kane, BC 07-1&2
         Review of Topics Covered So Far
 1. Central role played by information and by accounting
    concepts in dealmaking and net-worth measurement
 2. Accounting statements and concepts as informational
    tools that book changes in ways that can disinform
    outsiders -- Exercises
 3. Varieties of dealmaking: looked at three simple types
 4. Diagrams of deal types -- direct vs. indirect finance

 [Course Theme: Permissible leeway in constructing
   accounting statements provides “safe-harbor” to
   would-be deceivers: GAAP generates “GAAA!”
   (Generally Accepted Accounting ABUSES).]
Edward Kane, BC 07-1&2
      Four More Basic Dealmaking Categories
              to Diagram in Week 2

        d. Credit enhancement
        e. Role of FDIC
        f. Securitization
        g. Mutual Funds

Edward Kane, BC 07-1&2
     d. Direct Finance With Credit Enhancement
        (i.e., bonding of contract performance)

                         Funds (& Info)
      Surplus                              Deficit Spending
   Spending Units                               Units
                          Securities (&
                                         Fees (& Info)
                         Guarantee Contract
                             (& Info)

Edward Kane, BC 07-1&2
               Tasks of Credit Enhancer

       CREDIT ENHANCER guarantees [i.e.,
      “bonds”] the performance of a borrower’s
     promise to pay the holders of a direct debt.
     The credit enhancer holds and manages the
    default risk of the loan. It must evaluate this
    risk to price the alternative of making a loan
        and to price its guarantee and set up a
     reserve for losses. But it does not need to
        fund the risk-free portion of the loan. 68
Edward Kane, BC 07-1&2
            Why Would a Borrower Pay for an
    A borrower’s credit-enhanced security bears a lower
    interest rate. Because the enhancer puts its own
    credit on the line, an enhanced security resembles the
    indirect debt that an intermediary might issue against
    a pool of similar direct debt held for its own account.
    The enhancer incurs much the same due-diligence
    and transactions costs as a direct lender, which must
    be covered out of its fee.
     • An example is mortgage insurance.

Edward Kane, BC 07-1&2
          How may a High-Quality “Credit
        Enhancer” Improve on Direct Finance?
     • Inserts itself into the Flow of Information and
     • Obviates lender Due Diligence & Expertise
     • Parallel to a Landlord’s Getting a Parent to Co-
       Sign an Apartment Lease
     • Basis for Earning Profits: presumption that the
       enhancer already knows things that would be
       very costly for a direct lender to verify
Edward Kane, BC 07-1&2
     e. Indirect Finance with FDIC Credit Enhancement
                                                    Funds &
                         Funds                     Monitoring
   Surplus                          Financial                                Deficit
                                                  Direct Securities
  Spending           Indirect    Intermediaries                             Spending
    Units           Securities
                                                      (& Info)
                                             monitoring &
                     (& Info)                enforcement
                                  (&Info)                  FDIC
                    Guarantee                             Enhancer              weak
                                                                                monitoring &
                                                            (Little Info)       enforcement
                                                            No Fee
                                                                            Industry and
Edward Kane, BC 07-1&2

        f. Securitization separates the functions of originating and
        servicing asset pools from the funding of these pools
                 By collateralizing an asset pool (e.g., of mortgage
        loans) and dedicating its proceeds specifically to servicing a
        particularized set of instruments without recourse, an
        institution effectively takes the underlying assets off its
        books and sells them to the owner of the asset-backed
        security. This replaces intermediation by a set of activites
        that generalize “financial brokerage.”
                 Heavily engineered forms permit cash flows from the
        pool to be stripped and recombined into securities contracts
        that an intermediary may sell either into wholesale capital
        markets or to retail customers.
Edward Kane, BC 07-1&2
           Diagram of Nonrecourse Securitization

      Deposit            Loans + Servicing
                         & Monitoring                  Securities &
    Institution          Commitment          Conduit      Info
    Originates                                Firm                    Investors
     and Sells                funds                        funds
      Pool of

Edward Kane, BC 07-1&2
       Securitization vs. Intermediation
     Surplus Unit: holds bonds supported by a
       specific loan pool vs. deposits supported by
       all bank assets and net worth
     Bank: sold to conduit vs. loan originated is
       funded by indirect debt
     Conduit: does not arise in indirect finance
     Deficit Unit: no difference

Edward Kane, BC 07-1&2
     g. Pure Pooler (Mutual Fund, Limited Partnership)
                                   P                Deficit Spending Unit #1
                                   O   (& Info)
                                   O     funds
 Spending                                           Deficit Spending Unit #2
   Units           claims to pro       securities
                   rata share of                               •
                                   L   (& Info)
                   returns, less            •

                   management                                  •
                   fee (& Info)    E        •
                                                    Deficit Spending Unit #N
                                   R   securities
                                       (& Info)

Edward Kane, BC 07-1&2
      Characteristics of Collective investment
                 funds of any kind
    • Investors’ money pooled together into portfolio of
    • Pooled portfolio is managed by professionals for a
      fee, using principles taught in “Investments” courses
    • Net Worth of Investors bears all risk. Two main
       – Market
       – Operator
    • Investors’ returns in proportion to ownership share
    • Two sources of managerial discipline: Regulation and

Edward Kane, BC 07-1&2
        Hedge Fund (HF) vs. Mutual Fund

     1. Similarity: Both are pooled investment
     2. Main Differences:
           a.    Management Strategy
           b.    Management Compensation Scheme
           c.    Exposure to Government Regulation
           d.    Ownership Structure

Edward Kane, BC 07-1&2
          What is a Hedge Fund (HF)?
         HEDGE FUNDS typically are private, largely unregulated, limited
           partnerships with wealthy individuals and institutional investors as
           limited partners and the manager/investment advisor as the general
           partner. *A hedge fund can employ explicit and imbedded leverage,
           thereby amplifying the variability of outcomes. It restricts redemptions
           so that the investment is largely illiquid. (Financial Economist
           Roundtable, 2005)

         No government limitations on investment powers; any limits come from
            specific elements of a voluntary contractual agreement. Advisers’
            marketing story promises benefits from escaping the dead hand of

           Combine liquid and illiquid long positions, short positions, derivative
           positions (some of whose prices managers may influence or even set
           themselves in OTC markets).

          * Innovation: KKR has listed an HF on the Amsterdam Stock Exchange.
Edward Kane, BC 07-1&2
                   Differences in Strategy
     •      Basic strategy of an MF is to hold leveraged
            long positions in fairly standard instruments
            (stocks and bonds) (Daily focus of managers is
            what instruments to buy or sell).
     •      Broader strategies are employed by an HF:
           1)    Incorporate short positions
           2)    Use leverage
           3)    Trade aggressively in derivative instruments
           4)    Limited partnership or LLC structure

Edward Kane, BC 07-1&2
       Difference in Compensation Schemes
     HF managers charge two-part fees:
     1. 1 to 1.5 percent of assets under
     2. Plus an incentive “profit-participation” fee
        (usually 20% of profits the portfolio earns
        over previous “highwater mark.”

Edward Kane, BC 07-1&2
       Difference in Government Regulation
     1. MF vehicles and their managers must
        register with the SEC if they want to be
        open to all investors: results in SEC
        oversight for disclosure, audits, and
        informal controls.
     2. HF managers generally avoid both types
        of registration by accepting a sufficiently
        small number of investors into the fund
        and making sure that these investors
        qualify as “accredited” or
Edward Kane, BC 07-1&2
                 HFs Back-Office Activities
                     to Other Entities
     1. Prime Brokerage: execute trades, manage
        cash flows, office space, and technology
     2. Law Firms: documentation and
        compliance consultants
     3. Accounting Firm: determines fees
     4. Administrators: keep records and custody.

Edward Kane, BC 07-1&2
Differences between a hedge fund and a mutual fund evolve
    with exceptions to rules requiring SEC registration of
           “Advisers” and “Investment Vehicles”
 •      Hedge Fund (Industry has about $1.3 trillion in assets)
     1) managers can sell stock short, use “leverage” (i.e., using borrowed
        funds to boost returns), and invest in “anything that moves.”
     2) investors must put in at least $x-thousand, usually accept a
        minimum “lock-up period,” and agree to managerial compensation
        that consists of fixed percentage fee plus an amount geared to
        performance relative to a “highwater mark.”
     3) “Private-placement” stance may exempt them from SEC reporting
        restrictions: not required to publicly disclose trades made, positions
        taken or losses experienced.
     4) Returns possess option-like features, including a definite risk of
     5) Managers have sometimes extracted corrupt trading privileges at
        mutual funds.

Edward Kane, BC 07-1&2
       What Might Exam Questions on
        Previous Material Focus On?
     1. Briefly Explaining Themes, Issues, Policy
       Problems, Concepts, Distinctions, Facts, or
       Managerial Perspectives.
     2. Performing Instructive Calculations
       Covered in Exercises and Pre-Exam Review
     3. Theory of Examsmanship (Identify and use
       course “megacepts”)
Edward Kane, BC 07-1&2
                Potential Policy Concerns
            1. Investor Protection: from nontransparency of
               trading, speculating, and lending the advisor
               undertakes. Societal controls focus on setting
               minimum investment levels and minimum investor
               income and net worth)
            2. Systemic Risk: Does the enforceability of risk
               transfers fall apart in market crises?

                RE-REGULATION: Three major loopholes
                existed in the Feb. 2006 SEC effort to force
                investment advisors to register:
                     Assets < $30 million or fewer than 15
                     investors or lock-up period exceeds two
                BUT a federal court ruled that this action exceeded
                the SEC’s authority.                              85
Edward Kane, BC 07-1&2
       Potential Three-Part Exam Question

     • Name three types of dealmaking that may
       be categorized as indirect finance.
     • Under what conditions can an FSF make a
       profit in each type?
     • Why doesn’t competition from direct
       lenders eliminate profit opportunities in
       each other kind of deal making?

Edward Kane, BC 07-1&2
  Megacept #6: Overcoming Charter Limitations

     Government Intervention in Finance Leads to
     Repeated Collisions Between Political & Economic
     Forces: Regulatory Dialectic conceptualizes the
     incentive conflicts regulators and regulatees face.
     • Regulation = Thesis
     • FSF Avoidance = Antithesis
     • Re-regulation = Synthesis (new thesis)

Edward Kane, BC 07-1&2
              Many FSF Innovations are Partly
     “Banks are at a historic crossroads as they
       evaluate the profitability of their traditional
       lending business. Increasingly, banks can
       create value for shareholders by originating
       and structuring credits, bundling and
       unbundling risk, providing research, and
       handling trades --but not holding credits.” (JPM
         CEO, 1999):
     • U.S. Banking industry has metamorphosed from merely a loan
       holder to a creator, enhancer, and distributor of loans. This cut
       its need for “regulatory capital” in half. (JPM itself continues to
Edward Kane, BC 07-1&2

Edward Kane, BC 07-1&2

Edward Kane, BC 07-1&2
Edward Kane, BC 07-1&2
                     Parent-Child Example

                            Avoidance of

Edward Kane, BC 07-1&2
               Example Studied During Term

     Regulation = uniform capital requirements on all
       bank loans in 1990 [What potential compliance
       costs? ANS: Proportional to (Kreqd – Kpreferred)]
     Avoidance = securitization of low-risk loans (How
       is burden lowered? ANS: Increasing portfolio risk
       raises Kpreferred)
     Re-Regulation = new capital requirement structure
       (still being worked out 18 years later)

Edward Kane, BC 07-1&2
                 Megacept #7
     Every FSF May be Divided into Four
     Functional Areas that are Morphing
       Separately and Together with FS
     •   Transactions Processing
     •   Intermediation of Funds & Risk Exposures
     •   Information Management & Distribution
     •   Systems and Product Support
Edward Kane, BC 07-1&2

Edward Kane, BC 07-1&2
            Declining Charter Relevance
     • The heart of a financial institution’s business is to
       test and intermediate three things: (1) flows of
       information, (2) cash flows, and (3) contracts
       between surplus and deficit units and within the
     • A High-Tech View of financial intermediation
       portrays differently chartered financial institutions
       as fluid deal-makers that run information and
       contracting factories.

Edward Kane, BC 07-1&2
Breaking Through the Charter Barrier

Edward Kane, BC 07-1&2

                             ?   ?

Edward Kane, BC 07-1&2
  Cataloguing Types of Shape-Shifting
    in FSF Organizational Structure
     • Market-Structure Consolidation: Mergers
           1) economies of scale (including in political clout)
           2) economies of scope
     • Globalization of Markets and Institutions
     • Product-Line Convergence across Charter
       Types via Product Substitution
     • Electronification or Digitization of Contacts,
       Processes, and Contracts
Edward Kane, BC 07-1&2
 Conceptual Fluidity is Needed to Characterize the
               Financial Industry
• Another way to describe FSFs: Suppliers of diverse,
  time-dated wealth-transfer contracts that substitute
  imperfectly for one another.
• Wide range of competitors:
   – Incumbent In-Market Competitors
   – Actual and potential new entrants
         • FSFs with a similar government charter
         • FSFs with a different charter (e.g., credit unions, securities
         • Nontraditional competitors with informational and deal-making
            capacities                                                 100

         • Foreign
 Edward Kane, BC 07-1&2 FSFs
   = Trying to
  Customers in
Edward Kane, BC 07-1&2

Edward Kane, BC 07-1&2
         Signs Over Product Windows
      Illustrate Three of the Four P’s of
              Retailing Anything
     • Product Focus
     • Promotion: Customer Focus
     • Place: Locational Focus (vs. either internet
       or “private” banking)
     • Price (not posted): Need for Cost Efficiency
       & Reputation
Edward Kane, BC 07-1&2
    SENIOR CITIZENS The letter, shown below, is an actual letter that was
    sent to a bank by a 96 year old woman. The bank manager thought it amusing enough to have it
        published in the New York Times.
    Dear Sir:
        I am writing to thank you for bouncing my check with which I endeavored to pay my plumber
        last month. By my calculations, three nanoseconds must have elapsed between his presenting
        the check and the arrival in my account of the funds needed to honor it. I refer, of course, to
        the automatic monthly deposit of my entire salary, an arrangement which, I admit, has been in
        place for only eight years. You are to be commended for seizing that brief window of
        opportunity, and also for debiting my account $30 by way of penalty for the inconvenience
        caused to your bank. My thankfulness springs from the manner in which this incident has
        caused me to rethink my errant financial ways. I noticed that whereas I personally attend to
        your telephone calls and letters, when I try to contact you, I am confronted by the impersonal,
        overcharging, pre-recorded, faceless entity which your bank has become.
        From now on, I, like you, choose only to deal with a flesh-and-blood person. My mortgage
        and loan repayments will therefore and hereafter no longer be automatic, but will arrive at
        your bank, by check, addressed personally and confidentially to an employee at your bank
        whom you must nominate. Be aware that it is an offense under the Postal Act for any other
        person to open such an envelope. Please find attached an Application Contact Status which I
        require your chosen employee to complete.
        I am sorry it runs to eight pages, but in order that I know as much about him or her as your
        bank knows about me, there is no alternative. Please note that all copies of his or her medical
        history must be countersigned by a Notary Public, and the mandatory details of his/her
        financial situation (income, debts, assets and liabilities) must be accompanied by documented
        proof. In due course, I will issue your employee with a PIN number which he/she must quote
        in dealings with me. I regret that it cannot be shorter than 28 digits but, again, I have
        modeled it on the number of button presses required of me to access my account balance on
        your phone bank service.
Edward Kane, BC 07-1&2
 As they say, imitation is the sincerest form of flattery. Let me level the playing field even further. When you call me, press buttons as

 •    1. To make an appointment to see me.

 •    2. To query a missing payment.

 •    3. To transfer the call to my living room in case I am there.

 •    4. To transfer the call to my bedroom in case I am sleeping.

 •    5 To transfer the call to my toilet in case I am attending to nature.

 •    6. To transfer the call to my mobile phone if I am not at home.

 •    7. To leave a message on my computer, a password to access my computer is required. Password will be communicated to you at a
      later date to the Authorized Contact.

 •    8. To return to the main menu and to listen to options 1 through 7.

 •    9. To make a general complaint or inquiry. The contact will then be put on hold, pending the attention of my automated answering
      service. While this may, on occasion, involve a lengthy wait, uplifting music will play for the duration of the call.

 •    Regrettably, but again following your example, I must also levy an establishment fee to cover the setting up of this new
      arrangement. May I wish you a happy, if ever so slightly less prosperous New Year. Your Humble Client (Remember: This was
      written by a 96 year old woman)

 •    "It galls me that a bank manager thought that amusing and that it does the bank no harm to have the letter published. He must think that it is a joke that people
      object to the impersonality and inconvenience of dealing with this institution. He just doesn't recognize that something is wrong, and it is not with the writer
      of the letter."...Paul Horvitz

Edward Kane, BC 07-1&2
“Competition Squeezes Profit Margins

Edward Kane, BC 07-1&2

Edward Kane, BC 07-1&2
                Minicases are meant to check your
                         understanding of main ideas

                                        What your

Edward Kane, BC 07-1&2
                       SHAPE SHIFTING
                   Minicase No. 1: Morphing of
                     Countrywide Financial
     • Chartered as a Mortgage Banker
     • Became a Bank Holding Company in 4-01
     • Became a Financial Holding Company in
     • Corporate Name Changes to Express
       Growing Ambitions
     • Continually Adding New Subsidiaries and
Edward Kane, BC 07-1&2
            5-Year Picture of CFC Stock

Edward Kane, BC 07-1&2
             Minicase No. 2: Banking Industry Efforts to
                  Keep Wal-Mart Out of Banking

Edward Kane, BC 07-1&2

      June and July 2004: Found a way to let customers cash
      checks and buy online.
      July 2005: Wal-Mart formally applies for ILC in Utah and
      FDIC approval.
 Edward Kane, BC 07-1&2
                         WALMART’S INTERIM SOLUTION

Edward Kane, BC 07-1&2
        Minicase Reading (others in lecture notes)
      Industrial Charter Could Be Wal-Mart's Way In
      From: American Banker
      Thursday, April 17, 2003
      By Rob Blackwell

      WASHINGTON - Wal-Mart Stores Inc. has failed in three attempts to enter the
      banking business, but observers say the Bentonville, Ark.-based retail giant has
      not yet conceded a strikeout.
      Since 1999 national and state lawmakers have nixed two applications by Wal-Mart
      to acquire financial institutions in Oklahoma and California. And this week
      Toronto-Dominion Bank's TD Bank USA announced that it has been unable to
      overcome regulatory obstacles in its proposed partnership with Wal-Mart to offer
      checking and savings accounts in as many as 100 stores.
      Community bank opponents, who claim its entry could overwhelm them, are
      already predicting that Wal-Mart will try again.
      "The problem with these financial services commercial mutants is that they can
      lose and lose and lose, but they only have to win the battle once," said Kenneth
      Guenther, the president of the Independent Community Bankers of America.

Edward Kane, BC 07-1&2
Minicase, cont.
  A spokesman for Wal-Mart said Wednesday that it had no immediate plans to pursue another
  such purchase. He would not speculate beyond that.
  Industrial loan companies are one of the few kinds of financial institutions that nonfinancial
  firms can own, and two bills in Congress that would lift restrictions on them could make them
  even more attractive, several observers said. [See related story.]
  Last year Wal-Mart applied to buy Franklin Bank of California. After community bankers
  mobilized against the application, a state law was passed preventing nonfinancial firms from
  buying industrial loan companies there.
  Such purchases are still legal in four other states - Colorado, Minnesota, Nevada, and Utah -
  and Wal-Mart's opponents are trying to eliminate those alternatives.
  Bankers are pushing a bill in Nevada that is similar to the California law. The bill passed the
  state Assembly's Commerce and Labor Committee on Friday - but, according to sources, only
  after an exemption was added to let Toyota Motor Corp. buy an industrial loan company there.
  A vote in the full chamber is expected next week; it would then go to the Senate for
  If the Nevada legislation is enacted, bankers are expected to lobby for similar bills in the
  remaining three states. They would probably face an uphill battle in Utah: As of the end of
  2001 there were 53 industrial loan companies in the United States - 20 of them based there.
  Utah regulators and lawmakers have shown little inclination to change its industrial loan
  charter. In an interview last year G. Edward Leary, the state's commissioner of financial
  institutions, defended it, saying that he "would not like to see the appeal of this charter
 Edward Kane, BC 07-1&2
Minicase, cont.
  But many observers had not expected California to restrict their ownership either.
  Randy Dennis, the president of DD&F Consulting in Little Rock, who advised Wal-Mart on its
  attempts to buy Franklin Bank and a unitary thrift in Oklahoma in 1999, called the California
  experience "frustrating" for him as well as for the retailer.
  Mr. Dennis said Wal-Mart has been portrayed incorrectly. He argued that bank ownership would
  simply be a way for it to save money on debit system processes - not to offer retail services.
  He added that the purchasing campaign, and the drive to partner with TD Bank USA and local
  community banks, have been intended to help Wal-Mart customers - 20% of whom do not have bank
  accounts, according to the company.
  "I'm surprised sometimes at the strong feeling people have about Wal-Mart," Mr. Dennis said. "They
  are interested in serving their customers and providing what their customers ask for."
  Legislative exceptions, such as the one for Toyota in Nevada's bill, are fundamentally unfair, he said. "I
  just have this sense of fairness against the idea that anybody in the world can own a bank but them."
  Chris Armstrong, Toronto-Dominion's chief marketing officer, said the partnership deal was called off
  because of a "regulatory challenge" from the Office of Thrift Supervision. He would not discuss the
  objection in detail, but several sources said the OTS saw the proposed partnership as giving Wal-Mart
  too much control over the branches, and thus violating the ban on mixing banking and commerce.
  Mr. Armstrong said there were no immediate plans to resurrect the deal, but he did not rule out doing
  so later.
  Wal-Mart could find another willing partner and attempt to overcome the regulatory obstacles,
  observers said.
  Most agreed the retailer would not quit.
  "They are not going to wave the white flag and go home," said Bert Ely, an independent analyst in
  Alexandria, Va. "So the first five attempts don't work. The next could give them the foothold they
  want."                                                                                          116
 Edward Kane, BC 07-1&2
                     Rest of Show is Self-Study
                     Sidelight on Delivery Systems

Edward Kane, BC 07-1&2
Edward Kane, BC 07-1&2
Edward Kane, BC 07-1&2
              Consolidation is and Local Market Structure
             Figure 1: National Occurring Within FSF Types
   40%                                                                                    2200

   30%                                                                                    2050

   20%                                                                                    1900

   10%                                                                                    1750
          1980           1983     1986        1989        1992         1995        1998

                  National deposit share held by the largest 10 largest banks (lef t scale)
                  Average Herf indahl Index in MSA markets        scale)
                  Average Herfindahl Index in SMSA markets (right scale)

Edward Kane, BC 07-1&2
                         Is Torturing Data Okay?

                                       NOW ARE YOU
                                      WILLING TO SAY
                                     BANK ACCOUNTING
                                       MAKES SENSE?

Edward Kane, BC 07-1&2
              Relationship Management at a
                       Hedge Fund

Edward Kane, BC 07-1&2

Description: Pro Forma Financial Statements Creator document sample