Chapter Twelve

Commercial Banks’
Financial Statements and
Analysis

McGraw-Hill/Irwin 12-1 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Why Evaluate Performance of
Commercial Banks (CBs)?
•• CBs
CBs are
are unique
unique in
in
–– the
the special
special services
services they
they perform
perform
–– the
the level
level of
of regulatory
regulatory attention
attention they
they receive
receive
–– the
the types
types of
of assets
assets and
and liabilities
liabilities they
they hold
hold
•• Managers,
Managers, stockholder,
stockholder, depositors,
depositors,
regulators,
regulators, and
and other
other parties
parties use
use
performance,
performance, earnings,
earnings, and
and other
other measures
measures
obtained
obtained from
from financial
financial statements
statements
McGraw-Hill/Irwin 12-2 ©2007, The McGraw-Hill Companies, All Rights Reserved
 Financial Statements of Commercial Banks

•• Report
Report of
of condition
condition
•• Report
Report of
of income
income
•• Retail
Retail bank
bank -- focuses
focuses on
on consumer
consumer banking
banking
relationships
relationships
•• Wholesale
Wholesale bank
bank -- focuses
focuses on
on commercial
commercial
banking
banking relationships
relationships

McGraw-Hill/Irwin 12-3 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Income Statement
•• Interest
Interest Income
Income
•• Interest
Interest Expenses
Expenses
•• Net
Net Interest
Interest Income
Income
•• Provision
Provision for
for Loan
Loan Losses
Losses
•• Noninterest
Noninterest Income
Income
•• Noninterest
Noninterest Expense
Expense
•• Income
Income before
beforeTaxes
Taxes and
and Extraordinary
Extraordinary Items
Items
•• Income
Income Taxes
Taxes
•• Extraordinary
Extraordinary Items
Items
•• Net
Net Income
Income
McGraw-Hill/Irwin 12-4 ©2007, The McGraw-Hill Companies, All Rights Reserved
 The Direct Relationship between the
Income Statement and the Balance Sheet
NN M
M

NI ==
NI 
rrnnAAnn -- 
 rrmmLLmm -- PP++NII
NII -- NIE
NIE -- TT
n=1
n=1 m=1
m=1
where
where
NI
NI == Bank’s
Bank’snet
netincome
income
AAn == Dollar
Dollarvalue
valueofofthe
thebank’s
bank’snthnthasset
asset
n
LLm ==Dollar
Dollarvalue
valueof ofthe
thebank’s
bank’smthmthliability
liability
m
rrn ==RateRateearned
earnedon onthethebank’s
bank’snthnthasset
asset
n
rrm ==Rate
Ratepaid
paidon
onthethebank’s
bank’smthmthliability
liability
m
PP == Provision
Provisionfor
forloan
loanlosses
losses
NII
NII == noninterest
noninterestincome
incomeearned,
earned,including
includingOBS OBS
NIE
NIE == noninterest
noninterestexpenses
expensesincurred
incurred
TT == Bank’s
Bank’staxes
taxes
NN == number
numberof ofassets
assetsthethebank
bankholds
holds
MM == number
numberof ofliabilities
liabilitiesthe
the bank
bankholds
holds
McGraw-Hill/Irwin 12-5 ©2007, The McGraw-Hill Companies, All Rights Reserved
 Financial Statement Analysis Using a
Return on Equity Framework

Time
Time series
series analysis
analysis
Cross-sectional
Cross-sectional analysis
analysis
Return
Return on
on equity
equity (ROE
(ROE))

ROE
ROE == Net
Net income
income  Total
Total Assets
Assets
Total
Total Assets
Assets Total
Total equity
equity capital
capital

ROA  EM
== ROA EM

McGraw-Hill/Irwin 12-6 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Return on Assets and Its Components

Return
Return on
on Assets
Assets (ROA)
(ROA)
ROA
ROA == Net
NetIncome
Income  Total
Totaloperating
operatingincome
income
Total
Totaloperating
operatingincome
income Total
Totalassets
assets

PM  AU
== PM AU

McGraw-Hill/Irwin 12-7 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Profit Margin

Profit
Profit Margin
Margin (PM)
(PM)

Interest
Interest expense
expense ratio
ratio == Interest
Interest expense
expense
Total
Total operating
operating income
income
Provision
Provision for
for loan
loan loss
loss ration
ration == Provision
Provision for
for loan
loan losses
losses
Total
Total operating
operating income
income
Noninterest
Noninterest expense
expenseratioratio == Noninterest
Noninterest expense
expense
Total
Total operating
operating income
income
Tax
Tax Ratio
Ratio == Income
Income taxes
taxes
Total
Total operating
operating income
income

McGraw-Hill/Irwin 12-8 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Asset Utilization

Asset
Asset utilization
utilization (AU)
(AU)

AU
AU ==Total
Totaloperating
operatingincome
income ==Interest
Interest ++ Noninterest
Noninterest
Total
Totalassets
assets income
income income
income
ratio
ratio ratio
ratio

McGraw-Hill/Irwin 12-9 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Net Interest Margin

Net
Net interest
interest margin
margin
Net
Net
interest
interest == Net
Net interest
interest income
income
margin
margin Earning
Earning assets
assets

== Interest
Interest income
income -- Interest
Interest expense
expense
Investment
Investment securities
securities ++ Net
Net loans
loans and
and leases
leases

McGraw-Hill/Irwin 12-10 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Spread

Spread
Spread -- the
the difference
difference between
between lending
lending and
and
deposit
deposit rates
rates
spread
spread == Interest
Interest income
income -- Interest
Interest expense
expense
Earning
Earning assets
assets Interest-bearing
Interest-bearing liabilities
liabilities

McGraw-Hill/Irwin 12-11 ©2007, The McGraw-Hill Companies, All Rights Reserved

 Overhead Efficiency

Overhead
Overhead efficiency
efficiency

Overhead
Overhead efficiency
efficiency == Noninterest
Noninterest income
income
Noninterest
Noninterest expense
expense

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 Liquidity Ratios
•• Advances
Advances to
to Deposits
Deposits ratio
ratio
=Total
=Total Advances/Total
Advances/Total Deposits
Deposits

•• Advances
Advances to
to total
total Assets
Assets ratio
ratio
=Total
=Total Advances/Total
Advances/Total Assets
Assets

•• Cash
Cash Ratio
Ratio
== Cash
Cash and
and its
its equivalents/Assets
equivalents/Assets
McGraw-Hill/Irwin 12-13 ©2007, The McGraw-Hill Companies, All Rights Reserved