1. Investment Banking, Insurance, and Other Sources of Fee Income
Chapter Fourteen
Investment Banking, Insurance, and Other Sources of Fee Income
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2. Key Topics The Ongoing Search for Fee Income
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Key Topics
The Ongoing Search for Fee Income
Investment Banking Services
Mutual Funds and Other Investment Products
Trust Services and Insurance Products
Benefits of Product-Line Diversification
Economies of Scope and Scale
Information Flows and Customer Privacy
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3. 14-3
Introduction
Financial institutions have faced a struggle recently to attract the funds they need in order to make loans and investments and boost their revenues
Whenever deposit growth slows, financial-service managers frequently are forced to pursue new sources of funds and new ways to generate revenue
Important source of growth in future revenues – fee income
Revenues derived from charging customers for the particular services they use
Monthly service charges on transaction accounts
Commissions for providing insurance coverage for homes and businesses
Membership fees for accepting and using a particular credit or debit card
Fees for providing financial advice to individuals and corporations
“Swipe fees” at the point of sale
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4. Introduction (continued)
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Introduction (continued)
The drive among competing financial firms to generate more fee income as an increasingly important revenue source comes from several sources
A desire to supplement traditional sources of funds (such as deposits) when these sources are inadequate
An attempt to lower production costs by offering multiple services using the same facilities and resources (economies of scope)
An effort to offset higher production costs by asking customers to absorb a larger share of the cost of both old and new financial services
A desire to reduce overall risk to the financial-service provider’s cash flow by finding new sources of revenue not highly correlated with revenues from sales of traditional services
A goal to promote cross-selling of traditional and new services in order to further enhance revenue and net income
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5. Sales of Investment Banking Services
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Sales of Investment Banking Services
One banking service that has been prominent, but volatile, is investment banking
Many leading U.S. banks recently either acquired or formed their own investment banking affiliates in order to serve corporations and governments around the world
For example, JP Morgan Chase’s acquisition of Bear Stearns
Leading investment banks in the world today:
Citigroup
JP Morgan Chase
Morgan Stanley
Goldman Sachs
Credit Suisse
UBS
Nomura Securities
Deutsche Bank
Raymond James
Banc of America Securities
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6. Sales of Investment Banking Services (continued)
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Sales of Investment Banking Services (continued)
Key Investment Banking Services
Traditionally, the best-known and often the most profitable investment banking service is security underwriting
The purchase for resale of new stocks, bonds, and other financial instruments in the money and capital markets on behalf of clients who need to raise new money
One of the most profitable underwriting services – initial public offerings (IPOs)
Leveraged buyouts (LBOs)
Involve the acquisition of a company, usually by a small group of investors, and typically are funded by large amounts of debt
Recently, many investment banks jumped into the hedge fund business
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7. Sales of Investment Banking Services (continued)
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Sales of Investment Banking Services (continued)
Examples of client questions that investment bankers can assist in answering:
Should we (the investment bank’s clients) attempt to raise new capital? If so, how much, where, and how do we go about this fund-raising task?
Should our company enter new market areas at home or abroad? If so, how can we best accomplish this market- expansion strategy?
Does our company need to acquire or merge with other firms? Which firms and how? And when is the best time to do so?
Should we sell our company to another firm? If so, what is our company worth? And how do we find the right buyer?
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8. Sales of Investment Banking Services (continued)
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Sales of Investment Banking Services (continued)
With passage of the Gramm-Leach-Bliley (GLB) Act of 1999, the full range of investment banking services was opened up for adequately capitalized and well-managed commercial banking firms
Research studies suggest that investment banking revenue and profitability are positively, but not highly, correlated with commercial banking revenues and profitability
There may be some significant product-line diversification effects
It is not yet clear that the benefits alleged from this new service dimension have offset the costs and risks involved
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9. Sales of Investment Banking Services (continued)
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Sales of Investment Banking Services (continued)
Investment banks today are wrestling with the question of what kind of financial firm they need to be in the future
What mix of services should they be offering to achieve high and sustained profitability?
A few commercial bank–investment bank combinations have shown promise for the future, despite ongoing struggles to fend off losses following a huge mortgage market meltdown in 2007– 2009
Recently both investment banks and commercial banks have been under intense pressure to raise large amounts of new capital
Many observers anticipate more mergers
It is not clear that future commercial bank-investment bank combinations will consistently turn out well
One likely outcome is greater government regulation
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10. Selling Investment Products to Consumers
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Selling Investment Products to Consumers
In recent years many of the largest business and household depositors have moved their funds out of deposits at banks and thrift institutions into investment products
Stocks, bonds, mutual funds, annuities, and similar financial instruments
Mutual Fund Investment Products
One of the most popular of the investment products
Each share in a mutual fund permits an investor to receive a pro rata share of any dividends or other forms of income generated by a pool of stocks, bonds, or other securities the fund holds
If a mutual fund is liquidated, each investor receives a portion of the net asset value (NAV) of the fund after its liabilities are paid off, based on the number of shares each investor holds
Proprietary funds versus nonproprietary funds
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11. Selling Investment Products to Consumers (continued)
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Selling Investment Products to Consumers (continued)
Annuity Investment Products
Annuities are a hedge against living too long and outlasting one’s savings
Fixed annuities promise a customer who contributes a lump sum of savings a fixed rate of return over the life of the annuity contract
Variable annuities allow investors to invest a lump sum of money in a basket of stocks, mutual funds, or other investments under a tax- deferred agreement, but there may be no promise of a guaranteed rate of return
Recently a new type of annuity contract has appeared, the equity- index annuity
Combines the features of both fixed and variable annuities
One advantage for financial firms selling this service is that annuities often carry substantial annual fees
One significant disadvantage with annuities sold through depository institutions is they typically compete with selling deposits
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12. Selling Investment Products to Consumers (continued)
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Selling Investment Products to Consumers (continued)
Several problems and risks are associated with sales of investment products
Current U.S. regulations require that customers must be told orally (and sign a document indicating they were so informed) that investment products are:
Not insured by the Federal Deposit Insurance Corporation (FDIC)
Not a deposit or other obligation of a depository institution and not guaranteed by the offering institution
Subject to investment risks, including possible loss of principal
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