Bank Investing

CHAPTER 2Financial Statement Analysis

Banks don't make bad loans in bad times; they make bad loans in good times.

– William J. McDonough, President and CEO of the NY Fed 1993–2003

Analyzing the financial statements of a bank requires a somewhat specialized framework. Unlike, say, a consumer, technology, or industrial company, banks are fundamentally balance sheet driven, with the income statement mostly a consequent output of interest earned on loans held on the balance sheet funded by interest paying deposits.

Despite requiring the development of some specialized knowledge, the endeavor is well worth it, as the fragmented and homogenized nature of banking means the skills you develop will be leveragable to a large universe of investable securities.

Though banks are predominantly balance sheet driven, banks still generate a decent chunk of revenues from fees (about 20% of net revenues for banks less than $10B in assets), while noninterest expenses can meaningfully impact profitability.

Cash flow statements are largely ignored for these cash flush financial intermediaries, doubly so as banks have unique access to the federal funds market and FHLB (Federal Home Loan Bank) advances among other pools of liquidity. Additionally, liquidity at these depositories is already tightly monitored by banking regulators. Further, as financial intermediaries, the application of US GAAP leads to some unintuitive results, such as deposit inflows being categorized as financing activities, underwriting ...