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Director's Corner

San Francisco Region Director's College Computer- Based Training
Earnings

How do Examiners Evaluate and Rate Earnings?
Examiners evaluate earnings from several different angles. We are going to touch on some of the main concepts that we use that you may find helpful as you review and discuss your bank's earnings performance. Examiners will assess:

  • Level, trend, and stability of earnings - Examiners will look for earnings fluctuations and try to determine the cause of those fluctuations. We use this information to estimate future earnings, taking into account items such as the next item.


  • Quality and sources of earnings - Are the primary sources of income from normal banking activities that you can rely on in the future? We will try to assess the amount that is attributable to non-recurring sources - like extraordinary gains or investment trading activities.


  • Ability to augment capital through retained earnings - The examiner's analysis will focus on this factor, especially in times of rapid growth or increasing risk.


  • Exposure to market risks - For most banks, this exposure is centered in interest rate risk. Maintaining higher levels of interest rates risk can create dramatic swings in income and could have negative implications for future earnings.


  • Provisions for loan losses - If the allowance for loan losses is not adequate for the risk identified in the loan portfolio, additional provisions will be necessary, which will lower net income.
Analyzing Earnings
One of the most useful and comprehensive sources of financial data on your bank is the UBPR - the Uniform Bank Performance Report. The UBPR is available free of charge at www.ffiec.gov. We will focus on just a few key earnings ratios that will help you monitor earnings performance. One fairly standard approach to this analysis is to follow what regulators typicaly refer to as the "Earnings Analysis Trail". It focuses on the following five items found on the Summary Ratios page of the UBPR under Earnings and Profitability.

 Net Income
Logically, the first item to look at is the bottom line to determine how well the bank is doing overall. The line item listed as Net Income in the Earnings and Profitability section is also known as Return on Assets (ROA). The ratio is calculated by dividing net income (after all expenses and taxes) by average assets.

Net Interest Income
The second step on this earnings analysis trail is the line item Net Interest Income (NII). This ratio is calculated by subtracting total interest expense from total interest income and dividing the result by average assets.

Non-Interest Income
The line item for Non-Interest Income mainly consists of service charges and miscellaneous account fees and is usually the second major type of bank income. Like the other ratios we have reviewed, this ratio is measured as a percentage of average assets.

Overhead Expenses
Overhead is accounted for as Non-Interest Expense on the UBPR. This item includes all operating expenses except for interest expense and provisions for loan losses. This line item includes expenses such as salaries, depreciation, consulting fees, and supplies. This ratio is more fully detailed on page 3 of the UBPR.

 Provision for Loan Losses
The last item that we will discuss in the Earnings and Profitability section is the Provision for Loan Losses. Our main concern here is whether the provisions are adequate to maintain the Allowance for Loan Losses at an appropriate level. If the allowance is too low relative to risk in the loan portfolio, additional provisions will be necessary, which must be taken out of earnings.

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Last Updated 06/29/2005 Supervision@fdic.gov

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