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    Financial Statements of Commercial Banks II

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    Ahmed El Khateeb
    1. An income statement for a commercial bank includes interest income, interest expenses, noninterest income, and noninterest expenses. Interest income from loans and investments makes up most revenues, while interest on deposits is the primary expense. 2. Net interest income is the difference between total interest income and expenses, and is a key determinant of profitability. Loan loss expenses are also deducted to arrive at net operating income. 3. Noninterest income includes fees from services while noninterest expenses include personnel costs, premises expenses, and other operational expenses. After-tax net income incorporates any gains or losses from security sales.

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    Financial Statements of Commercial Banks II

    Uploaded by

    Ahmed El Khateeb
    39 views14 pages
    1. An income statement for a commercial bank includes interest income, interest expenses, noninterest income, and noninterest expenses. Interest income from loans and investments makes up most revenues, while interest on deposits is the primary expense. 2. Net interest income is the difference between total interest income and expenses, and is a key determinant of profitability. Loan loss expenses are also deducted to arrive at net operating income. 3. Noninterest income includes fees from services while noninterest expenses include personnel costs, premises expenses, and other operational expenses. After-tax net income incorporates any gains or losses from security sales.

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    1. An income statement for a commercial bank includes interest income, interest expenses, noninterest income, and noninterest expenses. Interest income from loans and investments makes up most revenues, while interest on deposits is the primary expense. 2. Net interest income is the difference between total interest income and expenses, and is a key determinant of profitability. Loan loss expenses are also deducted to arrive at net operating income. 3. Noninterest income includes fees from services while noninterest expenses include personnel costs, premises expenses, and other operational expenses. After-tax net income incorporates any gains or losses from security sales.

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    39 views14 pages

    Financial Statements of Commercial Banks II

    Uploaded by

    Ahmed El Khateeb
    1. An income statement for a commercial bank includes interest income, interest expenses, noninterest income, and noninterest expenses. Interest income from loans and investments makes up most revenues, while interest on deposits is the primary expense. 2. Net interest income is the difference between total interest income and expenses, and is a key determinant of profitability. Loan loss expenses are also deducted to arrive at net operating income. 3. Noninterest income includes fees from services while noninterest expenses include personnel costs, premises expenses, and other operational expenses. After-tax net income incorporates any gains or losses from security sales.

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    of 14

    Financial Statements of

    Commercial Banks – II
    (Income Statement)
    Dr. Shabir Hakim
    Income Statement
    • An income statement, or Report of Income, indicates the amount
    of revenue received and expenses incurred over a specific period of
    time.
    • There is a close correlation between the size of the principal items
    on a bank's balance sheet (Report of Condition) and the size of
    important items on its income statement.
    – Assets on the balance sheet usually account for the majority of operating
    revenues, while liabilities generate many of a bank's operating expenses.

    FIN 342: Commercial Banking 2


    Components of an Income Statement
    • The income statement of a commercial bank can be divided into
    four main sections:
    1. Interest income
    2. Interest expenses
    3. Noninterest income
    4. Noninterest expenses

    FIN 342: Commercial Banking 3


    Interest Income
    • The interest earned from loans and security investments
    accounts for the majority of revenues for most depository
    institutions.
    • However, the relative importance of interest revenues versus
    noninterest revenues (fee income) is changing rapidly.
    • The fee income is growing faster than interest income on
    loans and investments as financial-service managers work
    hard to develop more fee-based services.

    FIN 342: Commercial Banking 4


    Interest Expenses
    • The number one expense item for a depository institution normally is interest on
    deposits.
    • The interest on deposits accounted for more than 60 percent of this bank's total
    interest costs.
    • Other interest expense items are the short-term borrowings in the money market,
    such as:
    – Federal funds (reserves) from other depository institutions
    – Repurchase agreements

    • Interest on the long-term borrowings, such as:


    – Mortgages on the firm's property
    – Subordinated notes and debentures outstanding

    FIN 342: Commercial Banking 5


    Net Interest Income
    • Net interest income (NII) is the difference between total interest
    income and total interest expenses.
    • NII is often referred to as the interest margin
    – The gap between the interest income the financial firm receives on loans
    and securities and the interest cost of its borrowed funds.

    • It is usually a key determinant of profitability.


    • When the interest margin falls, the stockholders of financial firms
    will usually see a decline in their bottom line-net after-tax earnings.

    FIN 342: Commercial Banking 6


    Loan Loss Expense
    • Loan loss expenses are deducted from current income and are
    commonly known as the provision for loan and lease losses.
    • The provision account is a noncash expense, created by a simple
    bookkeeping entry.
    • The annual loan loss provision is tax-exempt and is deducted from
    current revenues before taxes are applied to earnings.

    FIN 342: Commercial Banking 7


    Loan Loss Expense
    • There are two approaches to calculating provisions for loan losses:
    1. The experience method in which the amount of deductible loan loss expense
    would be the product of the average ratio of net loan charge-offs to total loans in
    the most recent six years times the current total of outstanding loans
    2. The specific charge-off method allows banks to add to loan loss reserves from
    pretax income each year no more than the amount of those loans actually written
    off as uncollectible.
    • Expensing worthless loans usually must occur in the year that troubled loans are
    judged to be worthless.
    • The largest banking companies are required to use the specific charge-off method.

    FIN 342: Commercial Banking 8


    Noninterest Income
    • Sources of income other than interest revenues from loans and investments
    are called noninterest income (or fee income).
    • The financial reports apportion this income source into four broad categories:
    1. Fees earned from fiduciary activities (such as trust services)
    2. Service charges on deposit accounts
    3. Trading account gains and fees
    4. Additional noninterest income (including revenues from investment banking, security
    brokerage, and insurance services).

    • Recently many financial-service providers have focused intently on


    noninterest income as a key target for future expansion.

    FIN 342: Commercial Banking 9


    Noninterest Expenses
    • The key noninterest expense item for most financial institutions is wages,
    salaries, and employee benefits, often referred to as personnel expenses
    – Has become an important expense item in recent years as leading financial firms have
    pursued top-quality college graduates and lured experienced senior management away
    from competitors.

    • The costs of maintaining a financial institution's properties and rental fees on


    office space show up in the premises and equipment expense.
    • The cost of furniture and equipment also appears under the noninterest expense
    category
    • Other expenses, which are small, include items such as legal fees, office
    supplies, and repair costs.

    FIN 342: Commercial Banking 10


    Net Operating Income and Net Income
    • The sum of net interest income and net noninterest income is the
    pretax net operating income.
    • Taxes are paid on pretax net operating income plus securities gains
    or losses
    • The after-tax income comprises the income before extraordinary
    items.

    FIN 342: Commercial Banking 11


    Net Operating Income and Net Income
    • Securities gains (losses) are usually small, but can be substantial
    for some financial firms at various times.
    • The activity of purchasing, selling, or redeeming securities during
    a year may result in gains or losses above or below the original
    cost (book value) of the securities.
    • A bank can use these gains or losses to help smooth out its net
    income from year to year.

    FIN 342: Commercial Banking 12


    Net Operating Income and Net Income
    • Smoothing of earnings
    • If earnings from loans decline, securities gains may offset all or
    part of the decline.
    • In contrast, when loan revenues ( which usually are fully taxable)
    are high, securities losses can be used to reduce taxable income.

    FIN 342: Commercial Banking 13


    Net Operating Income and Net Income
    • Smoothing of earnings
    • Another method for stabilizing the earnings consists of nonrecurring sales
    of assets.
    • These one-time-only (extraordinary income or loss) transactions often
    involve the sale of financial assets, such as common stock, or real property
    pledged as collateral behind a loan upon which the lender has foreclosed.
    – Such transactions, particularly loan foreclosures, have a substantial effect on current
    earnings
    – The collateral is carried on the lender's books at minimal market value, but its sale
    price may turn out to be substantially higher.

    FIN 342: Commercial Banking 14

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