Chapter 4 Managing Non Interest Income NonInterest Expense

Non-Interest Income n All fees are NOT created equal n Some fees are stable

Non-Interest Income n Deposit Service Fees n Stable source of revenue n Relatively price

Non-Interest Expense(Overhead) n Personnel Expense n Wages, salaries, and benefits n Occupancy Expense n

Non-Interest Expense n Key Ratios n Burden (Net Overhead Expense) n Burden n (Non-Interest

Non-Interest Expense n Key Ratios n Efficiency Ratio Larger banks tend to have lower

Non-Interest Expense n Key Ratios n Efficiency Ratio © 2014 Cengage Learning. All Rights

Non-Interest Expense n Key Ratios n Operating Risk Ratio n Lower is better because

Non-Interest Expense n Key Ratios n Operating Risk Ratio © 2014 Cengage Learning. All

Non-Interest Expense n Key Ratios n Productivity Ratios n Assets per Employee n Average

Non-Interest Expense n Key Ratios n Productivity Ratios n Dollar Amount of Loans Per

Non-Interest Expense n Key Ratios n Productivity Ratios © 2014 Cengage Learning. All Rights

Which Lines of Business and Customers are Profitable? n Line-of-Business Profitability Analysis n Risk-Adjusted

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Analyses

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated,

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Expense

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Revenue

Which Lines of Business and Customers are Profitable? n Aggregate Profitability Results From Customer

Which Lines of Business and Customers are Profitable? n What Is The Appropriate Business

Which Lines of Business and Customers are Profitable? n Cost Management Strategies n Expense

Which Lines of Business and Customers are Profitable? n Cost Management Strategies n Operating

Which Lines of Business and Customers are Profitable? n Revenue Enhancement n Contribution Growth

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Chapter 4 Managing Non. Interest Income & Non-Interest Expense © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

Non-Interest Income n All fees are NOT created equal n Some fees are stable and predictable over time, while others are highly volatile because they are cyclical n Non-Interest Income has increased as a proportion of net operating revenue Largest contributors are deposit service charges and other non-interest income n Larger banks rely more on non-interest income than their smaller counterparts n © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 2

Non-Interest Income n Deposit Service Fees n Stable source of revenue n Relatively price inelastic n Large banks tend to charge more for these services than small banks © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 3

Non-Interest Expense(Overhead) n Personnel Expense n Wages, salaries, and benefits n Occupancy Expense n Rent and depreciation on buildings and equipment n Goodwill Impairment n Amortization from permanently impaired goodwill n Other Intangible Amortization n Other Operating Expense © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 4

Non-Interest Expense n Key Ratios n Burden (Net Overhead Expense) n Burden n (Non-Interest Expense – Non-Interest Income) § Lower is better n Net n Non-Interest Margin (Burden/Average Total Assets) § Lower is better © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 5

Non-Interest Expense n Key Ratios n Efficiency Ratio Larger banks tend to have lower (better) efficiency ratios because they generate more non-interest income n Low efficiency ratios do not always lead to higher ROEs n The lower, the better n © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 6

Non-Interest Expense n Key Ratios n Efficiency Ratio © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 7

Non-Interest Expense n Key Ratios n Operating Risk Ratio n Lower is better because proportionally more incomes from fees © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 8

Non-Interest Expense n Key Ratios n Operating Risk Ratio © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 9

Non-Interest Expense n Key Ratios n Productivity Ratios n Assets per Employee n Average Personnel Expense § Can be biased on the high side due to senior management compensation © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 10

Non-Interest Expense n Key Ratios n Productivity Ratios n Dollar Amount of Loans Per Employee n Net Income Per Employee © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 11

Non-Interest Expense n Key Ratios n Productivity Ratios © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 12

Which Lines of Business and Customers are Profitable? n Line-of-Business Profitability Analysis n Risk-Adjusted Return on Capital n Return on Risk-Adjusted Capital © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 13

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Analyses of customer profitability profiles suggest that banks make most of their profit from a relatively small fraction of customers n View is that 20% of a bank’s customers account for 80% of profits © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 14

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Expense Components n Non-Credit Services § Check-processing expenses are the major non-credit cost item for commercial customers n Credit Services § Cost of Funds § Loan Administration Expense © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 16

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Expense Components n Transaction Risk § Risk of fraud, theft, error, and delays in processing, clearing, and settling payments n Default Risk § Single largest risk n Business Risk Expense § Losses and allocations for potential losses © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 17

Which Lines of Business and Customers are Profitable? n Customer Profitability Analysis n Revenue Components n Investment Income from Deposit Balances § Earnings Credit n Non-Interest Income § Fee Income n Loan Interest © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 18

Which Lines of Business and Customers are Profitable? n Aggregate Profitability Results From Customer Profitability Analysis n Profitable customers maintain multiple relationships with the bank n Unprofitable customers tend to “shop” for the lowest price and do not use multiple products © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 19

Which Lines of Business and Customers are Profitable? n What Is The Appropriate Business Mix? n Some fee incomes from relatively stable services and lines of business, while other fees are highly volatile. n n One problem is that some managers view these volatile fees as permanent sources of income. Community banks do not have the same opportunities to enter investment banking and specialty intermediation. © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 20

Which Lines of Business and Customers are Profitable? n Cost Management Strategies n Expense Reduction n Outsourcing n Operating Efficiencies n Reduce costs but maintaining the existing level of products and services n Increase the level of output but maintaining the level of current expenses n Improve workflow © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 21

Which Lines of Business and Customers are Profitable? n Cost Management Strategies n Operating Efficiencies n Economies of Scale n Economies of Scope © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 22

Which Lines of Business and Customers are Profitable? n Revenue Enhancement n Contribution Growth n Allocates resources to best improve overall long-term profitability § Increases in expenses are acceptable and expected, but must coincide with greater anticipated increases in associated revenues. © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part. 23