Since the mid-1990s, when banks first reported retail investments income to the federal government, industry production could be characterized as “onward and upward.” Almost each year, income from the sale and servicing of annuities and mutual funds (investment income), as reported to the Federal Deposit Insurance Corp. and Office of Thrift Supervision, surpassed the totals from the year before (see Chart 1).
Last year was one of the few exceptions to the story, however.
In the first half of 2005, investment income at the nation’s banks and thrifts plunged 15% compared with the same period in 2004–from $3.3 billion to $2.8 billion, according to the Bank Insurance Market Research Group.
How to explain the decline? Interest rates, as is so often the case, are the main culprit, particularly in the way rates have affected fixed annuity sales. Fixed annuities have long been a staple in retail bank brokerage programs.
Indeed, FAs have accounted for some 50% or more of production at bank investment programs in many years over the last decade. In BIMRG’s “2004 Bank Insurance and Brokerage Productivity Study,” for instance, FAs comprised 49% of total investment sales, compared with 21% for variable annuities and 30% for mutual funds. In the 2002 study, fixed annuities comprised 59% of total investment sales, compared with variable annuities (15%) and mutual funds (27%). In the first half of 2005, by contrast, the fixed annuity share appeared closer to 30%.
In 2005, bank programs were hammered by a flat yield curve in which the interest rates offered by FAs differed little from what consumers could get from bank certificates of deposit. In such situations, bank customers invariably opt for the safer, more liquid, FDIC-insured CDs.
Here is a sampling of comments from institutions, as reported in Singer’s Annuity Funds Report.
At Michigan’s Citizens Banking Corporation, brokerage and investment fees totaled $5.9 million in the first nine months of 2005, a decrease of $300,000 or 4.8% from the same period of 2004.
“The decline was the result of lower fixed annuity sales in 2005, primarily related to a bonus annuity rate offered during the second quarter of 2004, and the current interest rate environment,” the company said in its third quarter earnings release. In an earlier report, the company cited “lower annuity sales in January and February 2005 due to competitive pressures from other interest-bearing products.”
Comparing the first six months of 2005 with the first six months of 2004, Huntington Bancshares noted in its 10-Q filing, “Brokerage and insurance revenue [$26.57 million] decreased $2.6 million, or 14%, mainly as a result of an 18% decline in annuity sales volume. The annuity sales volume decline reflected a lower demand for fixed annuity products resulting from the rising interest rate environment combined with fewer carrier promotional rate offerings.”
At MB Financial Inc., the $5.7 billion (assets) Chicago-based holding company for MB Financial Bank, N.A. and Union Bank, N.A., brokerage fees fell $1.8 million in 2005 compared with the previous year.
“Brokerage fees declined because of lower fixed annuity sales, loss of key clients due to acquisitions and turnover of financial advisors due to the difficult market in 2005,” said the company.
This decline in first-half investment income was evident in all bank asset-size categories. Chart 2 shows investment income for the median, or middle-ranking institution, in five asset-size groups.
Was 2005 an aberration, or can we expect more of the same in 2006? If the federal fund rates continue to rise, as they did in late 2005, that will boost short-term rates–and bank CD rates–but will do little for fixed annuity sales. What’s needed is a return to the traditional yield curve where long-term investments bring a substantially higher payout than short-term instruments like bank CDs.
How much of a gap is necessary? About 2%–i.e., between the yield on one-year CDs and fixed annuities (including a first-year bonus rate)–according to industry consultant Kenneth Kehrer, who has been tracking this relationship for years.
It is then and only then that the industry’s investment income is likely to resume its historic climb.