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Next round to the small banks
By Jim Campbell, principal and senior vice-president of Reagan Consulting, Inc., www.reaganconsulting.com, where he leads the firm’s banking industry practice.
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(404) 233-5545.
Changed landscape now favors community banks to pick up the slack in agency acquisitions
A decade ago, the banking industry was captivated by its prospects in the insurance brokerage business. And rightly so. Years of battling for the opportunity to sell insurance were finally paying dividends.
To seize this opportunity, banks began aggressively buying insurance agencies. By 2000, banks were the most active acquirers in the market, completing 78 deals, or nearly 40% of all agency deals announced that year. Among those leading the way into the promised land of insurance sales were large banks including BB&T, Wells Fargo, First Tennessee, and Citizens Financial Group. Expectations soared.
Today, however, the landscape has changed, and bank insurance momentum has slowed (Exhibit 1). The capital crisis that has gripped the banking industry over the past couple of years has made agency acquisitions difficult for some banks. However, the beginning of the slow-down pre-dates the full force of the credit crisis and can be traced to a sequence of setbacks that unfolded over the past half-decade.
Soft prices sap momentum
The first setback for bank-insurance began in 2004 as property and casualty insurance pricing began to soften. As softening prices slowed agency growth and suppressed investment returns, bank boards began to reassess their agency acquisition strategies. Enthusiasm for more deals waned. By 2005, the banking industry’s share of the agency acquisition market had plummeted to 21.1% or roughly half its peak level reached three years earlier.
The following year, as banks tried to mount a comeback in the agency acquisition market, they encountered a second setback. The competitive situation had changed. The public insurance brokers, needing to supplement their woeful organic growth in a persistent soft market, were highly-motivated buyers. In addition, private equity was on the hunt and willing to pay premium prices. With the increased aggression of these two segments, banks had lost the pricing advantage they previously held and were finding it more difficult to compete for deals. Many announced they would forego agency acquisitions until the return of a more favorable market.
Insurance potential questioned
The third setback began to emerge by late-2006 and was in full-bloom by 2007. During this time, banks, including several leaders of the bank-insurance movement, were questioning the results of their efforts in insurance.
Although most acquired agencies were performing at least reasonably well, some had failed to contribute meaningfully to the overall performance of the bank. They were deemed “ancillary,” “non-core,” or “non-essential.” Ultimately, some banks divested, among them Bank of America, Union Bank of California, Capital One, and Webster Bank, all of which sold insurance agencies that were among the 100 largest in the U.S.
Unlike the first two setbacks, which were driven largely by market cycles, this third setback hit at the core of bank-insurance, questioning the potential for insurance sales to make a relevant contribution to the banking industry. The 2008 American Bankers Insurance Association (ABIA) Study of Banks in Insurance found that, for 66.2% of surveyed banks, the primary objective for selling insurance is to “increase noninterest income.” This suggests that, in order to be relevant to the performance of the bank, an insurance agency must make a material contribution to the bank’s noninterest income growth. Clearly, some banks were determining that, for them, this threshold was unattainable.
Relevance is relative
But what about other banks? Was this an indictment of bank-insurance generally or was it still possible for other banks to achieve the objective of meaningful noninterest income growth through insurance sales? The 2009 Michael White—Prudential Bank Insurance Fee Income Report sheds some light on these questions. Analyzing data from approximately 9,500 commercial banks and 1,000 bank holding companies, this report provides the percentage of noninterest income each of these BHCs derived from insurance brokerage fee income, a metric referred to as “noninterest income (NII) concentration.” Following are two key findings from this analysis (see also Exhibit 2):
• For the 50 largest U.S. BHCs (Group 1), median insurance brokerage fee income is $9.6 million, but median NII concentration is a paltry 1.0%. So, although the median bank in Group 1 is generating nearly $10 million through insurance sales, this income represents only 1% of the bank’s total noninterest income.
• For the 50 U.S. BHCs with the highest NII concentration (Group 2), the median insurance brokerage fee income is only $4.1 million but the median NII concentration is a robust 36.5%.
Although there is no universal threshold for determining relevance, it seems reasonable to assume that the 1.0% contribution to noninterest income achieved by Group 1 would be considered irrelevant by most banks, but that Group 2’s 36.5% contribution would be considered highly relevant. Why is insurance income so much less relevant to the Group 1 banks? Because they are much larger. Median assets for the Group 1 banks are $62.4 billion compared to only $0.9 billion for the Group 2 banks.
Conclusion: relevance is relative. It’s harder to move the noninterest income needle in a large bank because the total noninterest income number is so much greater. Although the median Group 1 bank has more than twice the insurance brokerage fee income as does the median Group 2 bank, it has almost 60 times as much total noninterest income.
This inverse relationship between bank size and the ability to make a material contribution to noninterest income growth through insurance distribution will play a critical role in shaping the future of bank-insurance, perhaps most notably in the following two areas:
1. Community banks will lead
Change in the banking industry often starts at the top and trickles down. Larger banks were the first out of the gates in pursuing the insurance business, but many have now admitted that, for them, pursuing relevant scale in insurance is futile. BB&T and Wells Fargo have proved it can be done, but they are the exceptions. In fact, only five of the 50 largest U.S. BHCs are on the top 100 list for NII concentration (i.e., percent of NII derived from insurance brokerage fee income).
For community banks, however, relevant scale in insurance is generally more attainable. Consider the example of First State Bank in Webster City, Iowa. Having previously acquired more than a dozen small insurance agencies, this $242 million-asset bank generated approximately $4.5 million in insurance brokerage fee income last years, which accounted for 37% of First State’s net operating revenue and 76% of its noninterest income, according to Michael White Associates.
That’s a very high percentage, but more than 100 banks with assets under $5 billion currently earn 10% or more of their noninterest income through insurance sales.
2. Agency acquisitions drive growth
As demonstrated by the top 100 BHCs in NII concentration, most of which have acquired at least one insurance agency, the surest path to relevant scale in insurance is through acquisitions. Although cross-selling is an important part of the insurance strategy for most banks, it is more practically a means for strengthening existing bank customer relationships than for building scale. In addition, individual life and health insurance will be an important element of most bank-insurance strategies but will not do the heavy lifting of building scale. Why? Because individual life and health commission income is generally non-recurring. Conversely, property and casualty (and group benefits) insurance commissions provide a renewable source of noninterest income, with retention rates often in excess of 90%. Look for community banks to increasingly pursue acquisitions of property and casualty insurance agencies to build scale.
Many banks have seen some erosion in their noninterest income over the past two years. Community banks are no exception and can ill-afford to lose ground on this front as they generally have fewer sources of noninterest income than do larger banks. It is the community banks, therefore, that have both the greatest need for the additional noninterest income that insurance distribution can provide and the greatest opportunity to achieve relevant scale. BJ
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0909/index.php?startid=34
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