Analyzing a Bank’s Financial Statements: An Example

The financial statements of banks differ from most companies when analyzing revenue. Banks have no accounts receivable or inventory to gauge whether sales are rising or falling. Instead, several unique characteristics are included in a bank's balance sheet and income statement that help investors decipher how banks make money.

How Banks Make Money

Banks accept deposits from consumers and businesses and pay interest in return. Banks invest those funds in securities or extend loans to companies and consumers. When the interest a bank earns from loans exceeds the interest paid on deposits, it generates income from the interest rate spread. The size of this spread is a determinant of a bank's profit.

Banks also earn interest from investing cash in short-term securities like U.S. Treasuries and from fees charged for their products and services such as wealth management advice, checking account fees, overdraft fees, ATM fees, interest, and credit cards.  

Example: Bank of America Corporation (BAC)

The table below combines a Bank of America balance sheet and income statement to display the yield generated from earning assets and interest paid to customers on interest-bearing deposits. Most banks provide a similar table in their annual reports. 

• In GREEN: Interest or yield is shown that BofA earned from their investments and loans. Loans are assets because the bank earns interest income from loans.
• In RED: Interest expense and the interest rate paid to depositors are shown on their interest-bearing accounts. A deposit is a liability on a bank's balance sheet.

The balance sheet items are average balances for each line item rather than the balance at the end of the period. Average balances provide a framework for the bank's financial performance. There is a corresponding interest-related income, or expense item, and the yield for the period. Bank of America earned $58.5 billion in interest income from loans and investments while paying out $12.9 billion for deposits.

Income Statement

An example of Bank of America's income statement is shown below with the following highlights:

• Total interest earned was $57.5 billion for the bank from loans, all investments, and cash positions.
• Net interest income totaled $44.6 billion, which is the spread between interest earned from loans and the interest paid to depositors. 
• Non-interest income totaled $42.6 billion and includes fee income for products and services such as bank account and service fees, trust income, loan and mortgage fees, brokerage fees and wealth management services income, and income from trading operations.
• Net income of $18.2 billion was the profit earned.

A bank's revenue is the total of the net interest income and non-interest income.

Balance Sheet 

Bank of America's balance sheet example includes the following:

• Cash held as deposits was approximately $157 billion. 
• Securities are typically interest-bearing short-term investments that include U.S. Treasuries and government agencies. 
• Loans are commonly the largest asset on the balance sheet. BofA had $926 billion in loans.
• Deposits are the largest liability for the bank and include money-market accounts, savings, and checking accounts. Both interest-bearing and non-interest-bearing accounts are included. Deposits are critical to the bank's lending ability.

Bank Regulation

Banking is a highly leveraged business requiring regulators to dictate minimal capital levels to help ensure the solvency of each bank and the banking system. In the U.S., banks are regulated by:

• Federal Reserve System (FRS)
• Office of the Comptroller of the Currency
• Office of Thrift Supervision
• Federal Deposit Insurance Corporation (FDIC)

Interest Rate Risk and Credit Risk

Interest rate risk is the spread between interest paid on deposits and received on loans over time. Deposits are typically short-term investments and adjust to current interest rates faster than the rates on fixed-rate loans. 

If interest rates rise, banks can charge a higher rate on their variable-rate loans and a higher rate on their new fixed-rate loans. If interest rates rise, banks tend to earn more interest income, but when rates fall, banks are at risk as interest income declines. 

Credit risk reflects the potential that a borrower will default on a loan or lease, causing the bank to lose potential interest earned and the principal loaned to the borrower.

The Bottom Line

The financial statements of banks will differ from those of non-financial companies. Analysts look at net interest margin income and other fundamentals to value bank shares. Banks accept deposits from consumers and businesses and pay interest in return. They use deposits to issue loans and earn interest.

A bank generates income when the interest it earns from loans exceeds the interest paid on deposits. In the U.S., banks are regulated by multiple agencies, including the Federal Deposit Insurance Corporation (FDIC).