Composition of Bank Earnings

The table below shows the five core, or recurring, sources or uses of bank income:

  1. net interest income,
  2. total noninterest income,
  3. provisions for loan/lease losses,
  4. total noninterest or overhead expense, and
  5. income taxes.

Securities gains and extraordinary items, although reported quite regularly, are not a part of core earnings. This is because they consist largely of “one-time” or nonrecurring adjustments and are not a sustainable earnings source.

Core Sources or Uses of Bank Income Definition

Net Interest Income

Net interest income is the difference between total interest income and total interest expense. This is sometimes called "the spread,” or, when displayed as a percentage of average assets, the net interest margin.  Net interest income typically comprises about 65 to 80 percent of a bank’s total revenue, making it an important driver of a bank’s bottom-line performance.

Banks often set performance goals to keep their net interest margin above a certain minimum level. The best indicator of a bank's ability to sustain its net interest margin is its historical net interest margin and the composition of assets and liabilities on its balance sheet. Other factors that can affect this ratio include competition, economic and market conditions, and interest rate environment.

Total Noninterest Income

Total noninterest income is income other than interest income, such as service charges on deposit accounts, fees from the sale of insurance, loan origination fees, trading income and safe deposit box rent. This item has become increasingly important to banks as they find ways to supplement their income to offset declining net interest income due to increased competition.

Provision for Loan/Lease Losses

Provision for loan and lease losses is the amount set aside from current earnings to maintain an adequate Allowance for Loan and Lease Losses (ALLL). Directors should be alert to internal (e.g., change in lending staff) and external (e.g., plant closings) events that may influence the bank's expectation of losses in the loan portfolio and make inquiries regarding the ALLL as appropriate.

Total Noninterest or Overhead Expense

Total noninterest expense is typically divided into three categories:

  • personnel expense, such as compensation and employee benefit expenses;
  • fixed asset expense or occupancy, including rent, depreciation and maintenance; and
  • "other expenses," a catch-all for professional fees, FDIC insurance premiums, losses on sales of assets and all other expenses not classified under personnel and occupancy expense.

Values for this item tend to move with total noninterest income because of expense incurred to produce this income. Other expense is the expense item most often affected when banks try to reduce overhead costs. It is important that expense cuts be scrutinized particularly when they involve a reduction in internal controls. The need to gain operational efficiency must be balanced with the need to maintain adequate controls.

Income Taxes

Since 1997, banks have been able to elect subchapter S federal income tax filing status if they had 100 or fewer shareholders and met several other tests. Unlike a C-Corp that pays federal income taxes, an S-Corp does not. Instead, its shareholders each report a proportionate share of the bank's earnings on their personal federal tax form and pay taxes on it.