Bank Balance Sheets and

Income Statements

Unit Agenda

FDIC Website: UBPR, SDI, CTR

Overview of Bank Balance Sheets
Overview of The Income Statement
1. Components of Profits
2. Profitability Analysis

Unit Objectives
Students will be able to obtain information
on bank profitability from publicly
available records.
Students will be able to calculate
measures of bank profitability and explain
the significance.
Students will be able to use 6 steps of
profitability analysis for trend and peer
comparisons.

FDIC Data
In USA, bank deposits are insured by
government owned Federal Deposit
Insurance Corporation are required to
submit quarterly data on income and
balance sheets to regulator which is
available on-line in easy to use form.
UBPR Comprehensive set of quarterly
data for every bank in the US collected by
Federal Financial Instituting Examination
Council. Link.

Additional Data
Additional macro or industry level data from
FDIC & Fed linkable from the site.
Call and Thrift Reports Detailed Balance
Sheet and Income Statement for each
bank. Link
Statistics on Depositary Institutions Create
reports with customized peer groups. Link

Analyzing Bank Performance in HK

Data less easily available in consistent
comparable form.
Main source of bank data will be bank
annual reports. Most information is
available in annual and interim reports on
the web.
Less useful, because the data is not as
consistent across banks and not reported
as frequently.

Analysis
Peer Analysis - Compare with others in
same business situation
Trend Analysis Compare performance
with previous periods.
Learn About Bank Balance Sheets at HSBC
Subsidiary
HSBC National Association, USA

Balance Sheets
Assets

Liabilities

1. Loans

1. Transactions Accounts

2. Investment Securities

2. Savings and Time

Deposits

3. Noninterest Cash &

Due from Banks

3. Other Borrowings

4. Other

Equity

Peer Comparison: Assets

Source: SDI

Cert. 57890

Types of Bank Assets

Show Website on Screen
Cash and Funds Due:
Vault Cash
Deposits at Central Bank
Cash items in process of Collection

Types of Bank Assets cont.

Investments
Deposits at other banks
Lending of central bank reserves (to other banks)
Securities:

Maturity
1. Short-term
(<1
year)
2. Long-term
(>1
year)

Accounting
1. Held-to-Maturity (valued at cost)
2. Trading Account Securities
(marked-to-market)
3. Available-for-sale (marked-tomarket)

Composition of Securities

Types of Bank Assets, cont.

Net Loans and Leases, Loans to customers less
the allowances for loan losses.
Loan loss accounts are contra-assets, deductions
from value of loans which are chosen subjectively
(subject to regulatory approval).

Liabilities

Types of Liabilities
Deposits: Main source of funding for commercial
banks.
Volatile Liabilities in Red
Transactions Non Transactions
Non Interest Demand
Paying
Deposits

Small Savings Deposits

Interest
Paying

MMDA
NOW

Savings
Time Deposits < 100K
Time Deposits > 100K

Other
Volatile

Fed Funds, Brokered Deposits,

Foreign Office Deposits, Short-term
Borrowings

Types of Liabilities, cont.

Fed Funds Purchased: Short-term loans from
one bank to another with securities as collateral.
Trading liabilities: Obligations of banks securities
dealers.
Other Borrowed Money: Short-term borrowings
and commercial paper.
Subordinated Debt: Debt w/ maturity > 1 yr. and
junior to deposits.
Foreign Office Deposits: Deposits at Foreign
Subsidiaries.

Income Statement
NII

Net Interest Income:

Interest Income-Interest Expense

- Burden Non-interest Income-Non-interest Expense

- PLL

Provision for Loan Losses and Leases

+ SG

Securities Gains

-T

Applicable Taxes

+ XG

Extraordinary Gain

= NI

Net Income

Statistics For Depository

Institutions

Net Interest:
Key Source of Profits
Main business of commercial banks is
taking deposits at interest and making
loans or buying interest paying assets.
Net Interest Income (NII) =
Interest Revenue Interest Expenses
HSBC USA N.A.,
12/31/2005
Statistics For
Depository
Institutions

Sources of Interest Income

HSBC USA N.A., 12/31/2005 CTR

Statistics For Depository Institutions

U.S. Banks heavily dependent on income from property sector like
Hong Kong!

Sources of Interest Expense

HSBC USA N.A., 12/31/05 SDI
& CTR

Other sources of profits

Banks face other expenses (salaries, rent, etc.)
and have other sources of income such as fees
and services. Banks have an increasing role in
providing services to financial markets. In HK,
banks have many financial businesses including
credit cards, insurance, etc.
Burden
= Noninterest Expenses Noninterest Revenues

Sources of Non-Interest Income

HSBC USA N.A., 12/31/2005 SDI

US$, 000, CTR

Sources of Non-Interest Expense

HSBC USA N.A., 12/31/05 SDI

CTR

Loan Provisions
When loans are not repaid, these losses occur
they will have a negative impact on profits.
To prevent unexpected losses from leading to
fluctuations in profits, banks create a loan reserve
account.
Loan reserves are a contra-asset account, i.e. an
account of deductions from stock of loans.
Net Loans = Gross Loans Loan Reserves
When loans are not repaid, their amount is
deducted from Gross Loans & Loan Reserves
When bank makes Provisions for Loan Losses
this amount is added to Loan Reserves &
deducted from profits.

Etc.
Securities Gains: Changes in Mark-toMarket value of financial assets.
Extraordinary Items: One time gains and
losses on asset sales.
Taxes

Evaluating Bank Performance

ROE Analysis

Measures of Performance
Benchmark measure of a banks profitability
is the return on equity which is profits per
unit of dollars invested by the banks
owners. i.e. dollars of income divided by
equity in the bank.
Corresponds with a rate of return on
investment.
Items on the Income Statement are
generated over a period of time while items
on the Balance sheet are at a point in time.

Averaging Stock Variables

Example: Consider equity value of HSBC
USA, N.A., at ends of 2004 and 2005
compared with income earned over 2005.

Most appropriate to average balance sheet

variables over the year.
NI
Return on Equity ROE
Average Equity

Averages
Average of available balance sheets.
Quarterly (and semi-annual) income
statements report on a year-to-date basis. [e.g.
income on 9/30 is the income earned from
January through September].
To get appropriate denominator, start with end
of previous year and take average of end of
period balance sheets over the year.
Annualize.

HSBC USA Return on Equity

Year to Date Averages, Check against UBPR

Last Year
HSBC National Assoc.
Qtr by Qtr Averages SDI

Compare Q-by-Q ROE with UBPR

Quarterly Averages
For some balance sheet variables, such
as assets, banking firms construct day-byday or week-by-week averages and report
these on a quarterly basis.
Averages (across quarters) of these
daily/weekly averages are used to most
accurately calculate yields for UBPR.

Determinants of ROE
The first step in analyzing profits is to
decompose returns into the profitability of
assets and the leverage of the bank.

ROE ROA EM
NI
ROA
average Total Assets
Profitability of Banks Assets

average Total Assets

EM
average Total Equity
Leverage

Equity Multiplier
Banks owners earn profits on the spread
between interest on lending and the interest on
deposits.
When the leverage (EM) is high, banks are
accepting a lot of deposits and can earn high
income levels.
A high multiplier multiplies profits when profits
are positive. But in periods with negative profits,
negative profits may also be multiplied.
A high EM is a risk factor since it reduces the
amount of assets that can go bad without the
bank itself going bankrupt. Capitalization is a key pillar of
bank regulation

Dupont Analysis
ROA
Asset Utilization
Income Management

Expense Ratio
Cost Management

Tax
ROA AU ER
average Total Assets

Dupont Analysis (Bank Version)

ROA for all types of firms can be decomposed
into revenue and cost management.
AU = Asset Utilization (Revenue Management)
Revenues
AU
average Total Assets
ER = Expense Ratio (Cost Management)
Total Operating Expense
ER
average Total Assets

II. Earnings and Profitability Analysis

The Dupont Analysis can decompose
owners returns into cost management
and revenue management.
Profitability Analysis decomposes cost
management and revenue management
into narrower categories of cost and
revenue to evaluate the source of profits.

Asset Utilization
Securities
Gains
Asset Utilization (UA)

=
Non Interest Revenue/
Assets

Interest Revenue/
Assets

1. Rate
2. Composition
3. Volume Effects

Non Interest Income is growing as

a share of operating income

Source: Hoshi and Kashyap, 2002

Determinants of Net Interest

Income
Interest Earning assets as a share of assets
1. Volume Effects Earning Assets
Total Assets

2. Rate Effects: Level of interest earned on

assets of a given type.
3. Composition/Mix Effects: Types of interest
earning assets.

Yield Analysis
Banks with Assets > US$50 billion

Source: UBPR Custom Peer Group Reports

Expense Ratio and Cost Management

ER
Interest Expenses
aTA

1. Rate
2. Composition
3. Volume Effects

NonInterest Expenses
aTA

PLL
aTA

Efficiency Ratio
One measure of the ability to manage
costs is the ratio of expenses to revenue
EFF = Efficiency Ratio

Noninterest Expense
EFF
NII Noninterest Income

Analysis of Non Interest Expense

We may also want to
look carefully at the
sources of efficiency
with which banks
deliver services
% of Assets
Personnel Expenses
Total Expenses
Burden

Productivity
Measures
Efficiency Ratio
Personnel
Expense/Employee
Assets/Employee

Decomposition of Expenses
Banks with Assets > US$50 billion

Determinants of Net Interest

Expense
A. Interest Paying liabilities as a share of
assets Volume Effects
B. The interest paid on interest earning
liabilities:
1. Rate Effects: Level of interest paid on
liabilities of a given type. (TREND Analysis)
2. Composition/Mix Effects: Types of
interest bearing liabilities

Cost Analysis
Banks with Assets > US$50 billion

Source: UBPR Custom Peer Group Reports

Net Interest Margin & Spread

Concentrates on Rate & Composition Effects

NII
NIM
average Earning Assets

Spread

Interest Income
Interest Expenses

average Earning Assets average Paying Liabilities

Increasing Competition?

Profits vs. Risk

Earning high profits in good or even
normal times will be easier if the bank is
willing to take on some risk.
But this risk may be more problematic in
bad times.
Important to measure the risk of the
banking system as well as the profits.

Types of Risk
1. Credit Risk
2. Liquidity Risk
3. Market Risk

Interest Rate Risk

Foreign Exchange Risk
Stock market risk

4. Operational Risk

Business Risk
Legal Risk

5. Off-Balance Sheet Risk

Credit Risk: the risk that a borrower

will not pay back interest or principal
on a loan.
Evaluating Bank Credit Risk
History of Credit Performance (Chargeoffs)
Future expected losses (non-performing
loans, types of lending, diversification)
Strength of bank preparation (reserves,
earnings coverage).

Liquidity Risk
Variation in Net income caused by
banks difficulty in obtaining
immediately available funds.
1. Short-term obligations to shareholders
2. Liquid Assets
3. Other sources of liquidity

Interest Rate Risk

Variation in income and market
value due to effects of interest rate
changes on profits & present value
of assets and liabilities.
Gap between interest sensitivity of assets
and liabilities at different maturities.
Duration of assets and liabilities of bank.

Off-balance Sheet Items

Commercial Letters of Credit Banks guarantee
payment on trade related items.
Standby Letters of Credit Banks make loans
triggered by default on s-t borrowing or
commercial paper.
Loan Commitments Banks commit to lending
on borrowers demand.
Securitization w/ Recourse
Credit Derivatives Credit Guarantees
Financial Derivatives Interest Rate, Forex, etc.
Swaps, Futures & Options.

Comprehensive Risk Management

Modern banks use computer models to measure
market risk.
Based on historical data on correlations between
asset prices and assumptions about the
distribution of shocks (i.e. assume shocks are
normally distributed) the models will generate a
distribution of returns over any horizon.
Value at Risk models will predict some possible
loss which will be the maximum possible loss
with some percentage chance over some
forecast horizon.

Problems with VARs

Normal distributions assess a very low
likelihood of extreme, crisis events.
HKMA recommends balance sheets should be
stress-tested against some

Historical time series models are subject

to unexpected structural change.
Less good at evaluating losses from
infrequently traded assets like loans.

Other Risks
Operational Risk
Risk that operating
expenses may vary
significantly.
Crime & terrorism
Employee error or fraud

Legal Risk
Risk that lawsuits or
unenforcable contracts
might affect profitability or
solvency
Reputation Risk
Risk that negative
publicity may affect
customer base or
business opportunities.

Market Measures of Bank

Performance
Financial markets may be a measure of bank
performance.
Equity Markets: Common stock Book-to-Market
ratio measures markets perception of growth
potential and risk of assets.
Preferred stock and subordinated debt holders
are exposed to downside risk but not upside
gains from risky activities. Price of these assets
may help measure riskiness of activities.

Reading List
J.A. Lopez, Methods for Evaluating Valueat-risk Estimates SF FRB Economic
Review, 1999
Clark, Dick, Hirtle, Stiroh, and William The
Role of Retail Banking in the U.S. Banking
Industry: Risk, Return, and Industry
Structure NY FRB Economic Review 2007