The Role of Credit in Bank Earnings

Banks that sell stock are corporations just like other listed companies, but their quarterly balance sheets can look different. Instead of inventory and sales numbers, banks list loans and securities as part of their assets. Banks make their biggest profits on the interest they collect from a variety of loans. Quarterly and yearly financial reports can help investors to evaluate the role a bank’s loan-making operations play in its earnings and deliver important information about the health of these financial service corporations.

Earning Assets

Banks can list several different types of credit as assets on their balance sheet. Banks call these “earning assets” because of the profits their interest rates bring in. According to Motley Fool, banks earn their biggest profits from loans, averaging returns of six to eight percent. Banks also hold portfolios of stocks, bonds and other securities, but these assets return only four to six percent profit.

Leverage

Banks are one of the most leveraged industries in the market, meaning that their earnings are highly reliant on borrowing and lending money. If banks don’t get payments from their borrowers, then they may not be able to pay their own creditors. Because of this, federal regulators put strict rules on how much cash a bank must keep on hand and how much credit, or leverage, they can use.

Loan Losses

Banks anticipate some loans not being repaid, which is classified as “loan losses” on many bank earnings reports. When banks raise their loan loss reserves, it can be treated as an expense and have an impact on the banks earnings. Different types of loans -- such as business, construction or commercial real estate -- can incur different loan loss reserves. Bank managers may also raise loan loss reserves when economic conditions worsen.

Financial Reports

Investors can learn about what’s in a financial institution’s “loan book” through its 10-Q quarterly reports and 10-K annual report. These filings are part of the financial reports that the U.S. Securities and Exchange Commission require from public corporations. These reports supply a detailed list of the percentages of loan risk that financial institutions have undertaken, according to Motley Fool.

Types of Loans

A bank’s exposure to commercial real estate loans can create credit issues. If bankers loosen the terms under which they underwrite loans, it’s another sign that a bank has concerns about revenue and future earnings. Banks can be dependent upon a variety of loan types, with home mortgages being a large source of revenue. Automobile loans, credit card lending and investment banking are other common sources of bank earnings.

Photo Credits

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About the Author

Terry Lane has been a journalist and writer since 1997. He has both covered, and worked for, members of Congress and has helped legislators and executives publish op-eds in the “Wall Street Journal,” “National Journal” and “Politico." He earned a Bachelor of Science in journalism from the University of Florida.

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