BANKING AND FINANCIAL MARKET COURSEWORK

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  Balance Sheets and Profitability; AIA Insurance and Bank of America

  Brief Overview of Bank of America and AIA Insurance

  The Bank of America (BoA) was founded in the year 1904, hence it’s one of the oldest banks across the globe (Bank of America, 2019).  The Bank of America is the global leader in the management of corporate wealth, as well as investment banking.  The company offers a wide range of assets for corporations, governments, institutions and even to individuals.  It is headquartered in North Carolina in the USA.  AIA Group Limited, on the other hand, is the largest publicly listed company that deals in life insurance and securities business in Asia and Pacific regions.  Founded in 1919, AIA offers life insurance policy as its main product (AIA Insurance, 2019). Just like the Bank of America, AIA Insurance is listed in a number of popular stock markets mainly in the Middle East Market, though its headquarters is in Hong-Kong in China.

  The Balance Sheets of AIA and the Bank of America

  Table 1: Comparative balance sheets as at 3st December, 2019

  Bank of America (Dollars in Millions)			AIA group Limited (US$M)
  Assets	Liabilities and capital		Assets	Liabilities and capital
  Total Assets=$ 2,434,079	Total Liabilities=$2,169,269	Total Equity= $264,810	Total Assets =284,132	Total Liabilities =226,176	Total equity =57,956
  Cash & cash equivalents= 161,560			Cash & cash equivalents= 3,941
  Property, Plant & Equipment=10,561			Property, Plant & Equipment=2,865
  Equity as a % of total assets		11%	Equity as a % of total assets		20%
  Liabilities as a % of assets		89%	Liabilities as a % of assets		80%
  Cash and cash equivalents as a % of total liabilities		7.4%	Cash and cash equivalents as a % of total liabilities		1.7%
  Property, Plant & Equipment (PPE) as a percentage of total assets		0.4%	Property, Plant & Equipment  (PPE) as a percentage of total assets		1.0%

   

  Comparison and the contrast of the latest year-end balance sheet structures

              The balance sheets of the two organizations have used a largely similar format of presenting the information contained therein. All assets have been lumped together i.e. the insurance company and the bank did not separate total assets into current assets and non-current assets as is usually the practice in other firms. The two organizations have also lumped all the liabilities together i.e. they have not separated the liabilities into current and non-current liabilities as is usually the norm in many organizations.   The financial year of the two organizations ends in 31^st December of each year(Bank of America, 2019; AIA Insurance, 2019).

  The following information was obtained to contrast the year-end balance sheets structures of the two organizations.

  The first is a comparison of the total equity as a percentage of total assets as shown in the figure 1 below.

  Figure 1: Total Equity as a % of total assets

              As shown in figure 1 above, Bank of America maintained a higher equity amount at 20% of its total assets as compared to AIA Group Limited which maintained it at 11%.  Equity represents the net worth of the shareholders in an organization. It represents the portion of an organizations assets financed by the equity holders. In this case therefore a larger portion of the assets of Bank of America are financed by shareholders when compared with AIA (Danişman, 2018). This follows that more of AIA’s assets are financed by creditors when compared with Bank of America.

  The next contrast is a comparison of total liabilities against total assets as shown in figure 2 below.

  Figure 2: Total Liabilities as a percentage of total assets

  As shown in figure 2 above, the percentage of total liabilities to total assets was higher in Bank of America than in AIA.  This implies that Bank of America had higher liabilities as compared to its total assets than AIA. Liabilities represents the amount of assets of a company that are financed by creditors. This represents a financial risk since an organization would be at risk of bankruptcy if its unable to pay creditors on time due to adverse change in the business environment (Danişman, 2018). In this case Bank of America carried more financial risk in its balance sheet that AIA.

  The next contrast is demonstrated in figure 3 below.

  Figure 3: Cash and cash equivalents as a percentage of total liabilities

   

   

  As shown in Figure 3 above, the Bank of America held more cash to pay its liabilities when they fell due than AIA. This is a liquidity measure and it shows whether a company is able to pay its liabilities using its most liquid assets which is cash (Danişman, 2018).

  The next contrast is demonstrated in Figure 4 below;

  Figure 4: Property, Plant and Equipment (PPE) as a percentage of total assets

  Figure 4 above shows that Bank of America held more property, plant and equipment assets than AIA as at financial year that ended on 31^st December, 2019. Property, Plant and Equipment are non-current assets that are held by an organization. These assets are important because they are often used to secure loan facilities from financial institutions (Danişman, 2018). In this case Bank of America was at a better position than AIA to use its PPE assets to obtain credit facilities to finance business expansion in future.

  Part B

  Analysis of how the difference in AIA’s and Bank of America’s Roles are reflected in their balance sheet structures

              Bank of America just like any other bank in the world does the business of mobilizing customer deposits, giving out loans and investing its excess cash in interest earning securities. The bank’s biggest assets therefore relate to these transactions.  The banks biggest asset was loans and leases which stood at $ 983,426 million as at 31^st December, 2019. This represented financial resources lend out to clients and who repay with interest.  The banks largest liabilities also related to the business model of the bank were interest bearing deposits and non-interest bearing deposits which totaled $ 1,344,036 million(Danişman, 2018). These liabilities represented amounts owed to investors as interest bearing deposits with the bank and which are expected to generate interest payable on maturity.   These entries in the books of the bank represented the greatest liquidity risk for the bank. If the bank was owed more by investors than it could generate to pay, then it risked getting bankrupt(Danişman, 2018). The bank held cash and cash equivalents totaling $161, 560 million. This represented the most liquid assets that the bank held to pay its short term liabilities when they fell due and also meet running operating costs.   The bank must as a requirement maintain a certain amount of cash and cash equivalent to ensure it meets customer demands as and when they are made.  The bank is required to maintained a minimum capital ratio as required by the central bank. This explains the reason why the bank’s equity to risk weighted assets is very critical as if it falls below a certain minimum the bank risks contravening banking regulations and could be penalized (Jacques,2017). 

              Unlike the Bank of America, AIA undertakes insurance life business and also offers other financial services. Life assurance guarantees that, on the policy holder attaining a certain age or on death, he will receive a certain amount of money paid to him by the insurer.  Throughout the period of the policy the insured has to pay regular premiums.  The insurance company is therefore required to pay insurance claims made by policy holders when they fall due (Kulustayeva, Jondelbayeva, Nurmagambetova, Dossayeva & Bikteubayeva, 2020). AIA balance sheet reflected a total of US$189,597 million as insurance contract liabilities which was the largest liability as at the end of the financial year.  This represented the amount owed to policy holders that was due either within the following year or thereafter.  To ensure they do not fail to pay claims when they are made insurance companies invest the premium received in the money market or in equities market(Kulustayeva et al, 2020). The largest assets that AIA carried in its balance sheet was investments in debt securities and equities securities which totaled US$ 222, 306 million. These investments ensured the insurer was able to meet policy holders’ claims when they fell due.  This also represented the greatest liquidity risk since any adverse change in market conditions could lead to loss of revenue which would create liquidity problems.  The insurance company has hence invested in derivative financial instruments totaling US$ 971 million. These assets are aimed at mitigating the risk of sudden fall in rates which could be detrimental to the earnings of the insurer(Kulustayeva et al, 2020).

               AIA acts as a money market to individuals who wish to invest their funds. The company takes a certain amount from investors in form of deposits and invests it on behalf of the policy holders. The policy holders are, therefore, entitled to a particular interest monthly and annually. These amounts are reported as liabilities in the balance sheet. This is because the owners are entitled to withdraw the whole amount after a certain duration, or upon giving notice to the insurance company(Kulustayeva et al, 2020).

  Part C

  Different Ways of Measuring the Profitability of Bank of America

              Profitability refers to the ability of a company to generate profit for its shareholders (Chronopoulos et al., 2015). According to (Claessens Coleman & Donnelly, 2016), the profitability of a bank institution however, can only be measured using the financial ratios such as Return on Assets (ROA) and Net Interest Margin.

  Return on Assets (ROA)

              Return on Assets (ROA) is a financial ratio used to measure the profitability of a company relative to its assets (Dina et al., 2020). This ratio gives an investor an overview of how the company has been able to use its assets to generate revenue. ROA is calculated using the following formula;

  Return on Assets = Net Income/ Total assets

              Since its normally difficult to construct cash flow analysis of a bank accurately, most banks prefer using ROA to measure their profitability. The ratio indicates the profit earned per dollar of assets invested in the bank and hence it’s a critical ratio.  The ratio is a good measure of the quality of the management of the bank and its efficiency in utilizing the existing assets to generate income since most of the assets that the bank holds consist of money lend to customers (Ramesh, 2019).  A low ratio will therefore indicate that the bank’s management is inefficient while a high ratio shows that its management is strong and efficient(Ramesh, 2019).

  The ROA for Bank of America for the past five years is shown below;

  Table 2. Summary of ROA for the Bank of America in the Past 5 Years

  		Bank of America
  	2014	2015	2016	2017	2018	2019
  Total Assets	$2,104,534	$2,144,316	2,188,067	2,281,234	2,354,507	2,434,079
  Net Income	$4,883	$15,888	$17,822	$18,232	$28,147	$27,430
  ROA	0.23%	0.74%	0.81%	0.80%	1.20%	1.13%

   

  Figure 5 below summarizes the Return on assets Bank of America in the past five years;

  Figure 5. Comparative ROA for the Bank of America for the Past Five Years

  Figure 5 above shows that the return on assets the return on assets for the Bank of America has grown steadily from 0.23% in 2014 to 1.20% in 2018. The low return on assets should not be a point of concern as the ratio even if low may represent substantial revenues and profits since banks are usually highly leveraged world over (Ramesh, 2019).  It therefore appears that the bank has a strong and efficient management team.

  Net Interest margin

              Since banks’ core business is to provide loans from which they generate interest income, net interest margin is especially an important ratio in evaluating a bank’s performance over time.  Net interest margin reveals the ability of a bank to generate profits from its interest earning assets which primarily include loans and also other investment securities that it holds.  The predominant portion of a bank’s income is made up of interest income. Net interest margin is therefore a very important indicator in measuring how effective a bank is in carrying out its core business .  A bank that records higher margins generally implies that its more efficient and vice versa(Tu DQ, 2017).

    This ratio is also important because it measures how a bank is doing in relation to other banks in the market. It is also a good indicator on whether the bank has priced its financial products competitively or not. If the ratio is going down it may point to a problem with the pricing strategies used by the bank. It is also important in measuring how the economy is doing generally. If the ratio is falling it may imply people and businesses are avoiding loans since the economy is not doing well(Tu DQ, 2017).  The formula for calculating net interest margin is as follows;

  (Interest Returns-Interest expenses)/average total of earning assets

  Table 3. Summary of net interest margin for Bank of America in the Past 5 Years

  	Bank of America ($ millions)
  	2015	2016	2017	2018	2019
  Interest returns	49,507	51,057	57,579	66,769	71,236
  Interest expense	10,549	9,961	12,340	18,607	22,345
  Average total earning assets	884,749	895,446	926,356	937,294	974,010
  Net Interest Margin	4.40%	4.59%	4.88%	5.14%	5.02%

   

  The above can be presented graphically as follows;

  Figure 6: Net Interest Margin of Bank of America

  According to Figure 6 above, net interest income for the Bank of America grew during the five-year period. This implies that the entity operated profitably during the period. It also implies that the bank was able to generate income from its interest earning assets during the period.

  Limitations of ROA and Net Interest Margin

              The first advantage of ROA and Net Interest Margin is that that they are very simple to calculate. This is because one just uses data from the statement of comprehensive income and balance sheet (Claessens Coleman & Donnelly, 2016). The second advantage is that these ratios are easy to interpret  to make a prudent investment decision. This is because the final result is presented in percentages.  The next advantage is that data that is used to calculate them is comparative hence they are able to measure the trend performance of an organization. The next is that they can be used to make investment decisions as they are able to show the performance of a company over time (Hanzlík & Teplý, 2019). They can also be used for forecasting, planning and even budgeting as they provide important trend analysis information.  They can be used to measure the operational efficiency of the bank and also they communicate important information about the bank(Hanzlík & Teplý, 2019).

  Disadvantages

              These ratios have demerits in that they are prepared using historical information which may not give an accurate picture of the future state. The next demerit is that they do not take into account the impact of inflation on the performance of the bank(Hanzlík & Teplý, 2019). This is because they are prepared at a given point in time and by the time they are being communicated to stakeholders they are not adjusted for inflation. They information they provide is not realistic as a result.  The next disadvantage is that these ratios rely on information provided by management which may have been manipulated to provide a good picture of the bank(Hanzlík & Teplý, 2019).

  Conclusion

              The above ratios show that the Bank of America has been trading profitably for the five years reviewed. The ratios show that the bank has a strong management which efficiently utilizes available resources to generate profits for shareholders. There is merit in investing in the bank as it promises to make capital gains in future.