Saturday, October 02, 2010

Does it all have to be about the spread? My thoughts on fee income.

In a previous post I mentioned that my wife and I are refinancing our mortgage because of the extraordinarily low rates available (see link to that post below). As part of the process we received the Good Faith Estimate (“GFE”) of costs associated with obtaining a mortgage loan. A key and expensive component of the cost is title and settlement services. My lender suggested some service providers from their list, but we have a relationship with a local law firm that provides those services. This got me thinking about such services being offered by banks.

According to the GFE, title search, insurance, and settlement services will cost $2,073.75. Now, without giving you too much personal information, we do not live in a mansion. Our house is 2,000 square feet and its value is slightly greater than the average in our community. I recently heard on a personal finance show that the commissions to title agents are 70%-80%. Let’s assume they are something less for refi’s, say 50%. That would equate to over $1,000 of net revenue to the title/settlement agent for each transaction. I repeat that this is a residential real estate transaction refinancing an average home. Commercial real estate transactions and McMansions would generate greater revenue.

Given community banks’ propensity to do real estate transactions, why wouldn’t such a fee-based line of business flourish?

My company measures the profitability of products and lines of business for community financial institutions (“FIs”). Part of this service includes measuring how banks do, or don’t, make money on their fee-based products and lines of business. The chart below demonstrates the pre-tax profit margin since 2006 of all of the fee-based products for those Fis that subscribe to our service.

Community FIs, in general, are not making money with these products. Of course, there are exceptions, such as one of our clients that makes greater than a 20% pre-tax profit margin in their Trust and Retail Investments line of business. But as a general rule, community FIs have not been very successful in this arena. With the potential for diminished deposit fee income due to Reg E and the Durbin Amendment of the Dodd-Frank Act, perhaps FIs should figure out why this is so.

Retail investment services is one common service offered by community FIs and one that has confounded me as to why we can’t generate greater revenues and profits. According to a recent Wall Street Journal article (see link), the minimum commissions and fees expected of an Edward Jones broker is $30,000 per month, or $360,000 per year. Edward Jones’ business model is a main street model, having offices in small to medium sized towns across the country. One would think that a bank broker, similarly located and having the benefit of bank in-house referrals, should be able to outleg the Jones broker. However, Kehrer-LIMRA studies of bank broker productivity tend to hover around $250,000 of annual production.

As an industry, we should be successful in retail investment sales. Bankers, in spite of the recent and daily beatings we have taken in the media, remain a go-to source for trusted financial advice. As the table below indicates, publicly traded brokerage firms make a net profit margin of 17.81% at the median. I realize that the current environment has been challenging for them, but they still are generating profits as an industry. That profit margin includes taxes and all costs associated with their business, such as human resources, finance, and Charles Schwab himself. Therefore, shouldn’t we expect similar returns from our programs? Yet we settle for breakeven or worse. We should set our sights higher.

If we have a broker for every five or so branches, or covering $200 million of our deposit base, we should expect production in the Edward Jones area of $360,000, but certainly no less than $250,000. If we have four such brokers, generating $1 million in fee income, then we should expect a minimum of $200,000 pre-tax profit, fully absorbed. That means paying their share of HR, finance, etc.

Retail investments is one area where community FIs are well-positioned to succeed. But those fee-based lines of business that are consistent with your strategy should be explored, proper attention should be given, and profits should be expected. Those FIs that profitably meet the greatest amount of financial needs for customers already on their books will drive revenues and value that will be difficult to replicate. That is an enviable position indeed! What are your thoughts on complementary fee-based lines of business?

~ Jeff

Wall Street Journal article on Broker production:

Blog post on mortgage refinance:

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