PUBLISHED ARTICLES

The Acquisition Autobahn: Why some banks crash and burn after buying brokerages while others pass them by in the fast lane.

Leader's Edge, November 2007

Fast Focus

• Insurance agencies were once a "must have" for banks, but a strategic rethinking drives several to sell.
• Still, insurance investments pay off for banks that have a well-defined strategy and can overcome the culture clash.

Banks thought they had it made. The makeover of insurance on Main Street U.S.A. began in 1996 when the Supreme Court ruled that national banks selling insurance in small towns were subject to state regulation of insurance. At the same time, it said state regulation could not unreasonably interfere with the insurance activities of banks (Barnett Bank v. Nelson, 517 U.S. 25).

Three years after that decision, Congress adopted the Gramm-Leach-Bliley Financial Services Modernization Act, in essence tearing down the Chinese walls and firewalls between the different sectors of the financial services industry.

The advantages to banks, it appeared, were huge. The biggest advantage was the low cost of entry into insurance brokerage. And who can overlook the cross-sell opportunities? There were dollar signs dancing in the heads of bank executives. But how has it all worked out?

You Simply Must Have One

Since the passage of Gramm-Leach-Bliley in 1999, hundreds of banks have spent nearly $5 billion acquiring more than 500 insurance agencies. Buying an insurance agency was in vogue for several years, whether you were looking to build an insurance platform or have a one-hit wonder.

While those numbers are impressive, it hasn't always been a bed of roses for some of the acquiring banks. What appeared to be a slam dunk-the cross-sell opportunity-wound up being a foul shot caroming off the backboard. The basic problem was the difference in client bases between the bank and the insurance agency. The typical "foundation" agency, one with at least $5 million in commission revenue, earns most of its commissions and fee revenue from mid-sized to large commercial lines accounts. Typical bank customers are individuals or small-business owners.

Not only were the customer bases different, but imagine the respective cultures; they were as far apart as the Atlantic and Pacific oceans. The independent insurance agent's outlook is entrepreneurial; whereas, bankers take a more "corporate" perspective. And perhaps the real downfall of the cross-sell opportunity arose over the issue of compensation. Most bankers were not licensed, so paying them commissions was out of the question. On the other hand, the insurance agent is getting paid commission only. So, where is the incentive for the two to work together and be a referral source for each other?

Insurance agencies, at their core, are sales organizations. Without producers and adequate service and support staff, an agency cannot excel. Some banks have made the mistake of trying to cap a producer's earnings potential, only to crush the entrepreneurial spirit of the producer and cause sales to disappear or diminish greatly. The strategic post-acquisition plan must focus and build upon the cultures of both the bank and agency.

For some banks, it seems that either a strategic, post-acquisition plan was not implemented, or it just downright didn't work.

Less than 10 years after the passage of Gramm-Leach-Bliley, the pundits and the market believe that banks are failing in insurance because of a recent increase in the number of relatively large bank-insurance divestitures or announcements to divest. Let's recap what's happened so far this year.

Musical Boardroom Chairs

In February, Hub International, now under the umbrella of private equity firms, announced it was acquiring Hibernia Insurance Agency from Capital One Financial Corp., which had purchased Hibernia Corp. in 2005. The agency had revenue of approximately $18 million. The reason for the sale appears to be a no-brainer. When one refers to Capital One, one thinks of credit cards, not insurance. One month later, Hub announced it was acquiring BNC Insurance Services from BNCCorp. BNC Insurance Services had revenue of about $19 million. The reason for this sale isn't as straightforward. We will speculate in a bit. Hub appeared to be the bank seller's acquirer of choice, as Royal Bank of Scotland's Citizens Financial Group had sold its insurance brokerage business, with about $45 million in revenue, to Hub in 2006, and Hub also had acquired the insurance brokerage business of Fifth Third Bank of Cincinnati in 2002.

Bank of America (BOA) announced in May it was exploring strategic alternatives for its insurance unit. Despite having $78 million in brokerage revenue generated by U.S. clients at the end of 2005 and being the 27th largest bank-owned insurance agency of U.S. business, according to a Business Insurance survey, the insurance agency just does not appear strategically relevant for Bank of America. Insurance revenues accounted for a measly 1% (and that's rounding up!) of non-interest revenues at the end of 2005. BOA was never in the insurance brokerage business prior to its acquisition of FleetBoston Financial in 2004.

At the start of the year's third quarter, yet another bank announced its intentions to explore the sale of its insurance operations. In July, Webster Financial Corp., the parent of Webster Bank, announced it would do just that. For the year ending Dec. 31, 2006, Webster Insurance's revenue was about $39 million, a decrease of nearly 12% compared to the prior period. Reasons cited include decreased retention and decreased contingent revenue.

Are these bank divestitures or intentions to sell all failures or merely strategic decisions to divest of a non-core asset? The mirror has two faces.

Through the end of July, four banks have sold their insurance agency operations and two have announced intentions to do so. This number of banks exiting insurance brokerage hardly indicates widespread failure. That speculation has been aggrandized through recent announcements and the relatively large sizes of these bank-owned insurance agencies. Interestingly enough, during 2006, seven banks either sold a percentage of their insurance operations or divested themselves of the entire entity, but the scuttlebutt wasn't as great back then. Why now?

Here's why: The soft market coupled with the current interest rate environment has forced bank executives to analyze all bank operating segments under a high-powered microscope. Bank boards and executives are increasingly questioning their insurance investment from a strategic perspective and scrutinizing its return on capital relative to the overall bank return on capital. Again, culture comes into play as bank executives pay close attention to return measures and expect to meet or exceed these measures in spite of market conditions, while the insurance executive is just trying to tread water in a soft market.

Despite the recent attention cast upon bank-owned insurance brokerage divestitures, a great number of banks recognize that rewards, especially in terms of return on capital, do exist for both the bank and insurance operation, as long as the bank incorporates the insurance operation into a well-defined strategic plan. According to a survey by the ABA (American Bankers Association) Insurance Association and Michael White Associates, insurance brokerage fee income for bank holding companies increased 10.6% in 2006, and the mean ratio of insurance revenue to non-interest income was 14.8% among the top 50 in insurance revenue.

Non-interest income is one of the many reasons banks find insurance segments to be an integral part of their overall strategic vision. This revenue stream provides diversification to the standard operating lines of a bank. It may not always affect the bottom line, but in some cases, it can be significant.

Interestingly, BNCCorp's insurance revenues (of which there was no underwriting revenue) to non-interest income was a whopping 77% as of June 30, 2006. In 2005, the insurance brokerage unit contributed almost half of the bank holding company's profits. To echo one of baseball's greats, "Holy cow!" Why in the world would BNCCorp sell its insurance agency? We have no inside knowledge of why, but here's an educated guess: The bank effectively established its insurance presence with the 2002 acquisition of Milne Scali & Co., a large insurance brokerage headquartered in Phoenix. Five years later, earn-outs are over, employment agreements are expiring, and the insurance executives are looking for the exits. The same could be said for the three insurance agencies acquired in 2004. Without a well-crafted perpetuation plan for the insurance agency, even under the umbrella of the bank, who's left holding the bag? Ironically, the most likely reason Milne Scali probably sold in the first place may be the most likely reason the bank sells the insurance operations five years later.

Any Banks Still Buying?

The bank with the second largest percentage of insurance revenue to non-interest income as of June 30, 2006, was Greater Bay Bancorp, parent to ABD Insurance and Financial Services. In a different twist of fate, Greater Bay found itself attractive to another bank with a bank-owned insurance agency. In May, Wells Fargo announced an agreement to buy Greater Bay. Aside from the banking powerhouse this acquisition creates on the West Coast, it combines the fifth largest insurance broker of U.S. business (according to a Business Insurance survey), Wells Fargo Insurance Services, formerly Acordia, with the 15th largest broker of U.S. business, ABD. Parent Wells Fargo is committed to insurance brokerage as one of its four operating units and has announced two independent agency acquisitions this year as well.

From 2000 to 2006, BB&T led the leader board, with an estimated 32 announced insurance agency acquisitions. Wells Fargo was close behind with an estimated 29 announced insurance agency acquisitions. Twenty-one other banks have acquired five or more insurance agencies since 2000. (See Figure 1.)

The total number of bank acquisitions of insurance agencies decreased from a high of 84 in 2000 to a low of 48 in 2005, then increased to 55 in 2006. From an overall market perspective, financial institutions accounted for the lowest percentage of total transactions since 2000, coming in at 21% in 2006.

Several reasons can be attributed to this percentage decline, particularly as it relates to 2006 activity.

• Due to the continued soft market, public brokers continued to be very aggressive acquirers during 2006 to boost overall growth rates.
• More than 50% of banks involved in insurance distribution had already purchased their platform agency or agencies.
• Banks that already have their platform agencies have continued to focus on integration, cross-selling issues and reinvestment in infrastructure.
• There is a need for banks to focus on internal controls and related disclosures that are required by Sarbanes-Oxley.
• The price differential between banks and public brokers has narrowed or converged, particularly for subsequent acquisitions, which has led to increased competition.
• Public brokers are much more agile than banks in their ability to close transactions quickly, which becomes important to a seller when there is not a significant price differential.
• Privately held agencies have been opportunistic buyers, seeking add-on or roll-up acquisitions or opportunities to expand their geographic footprints.

This year, as of July 31, banks have acquired 25 insurance agencies. (See Figure 2.) Although banks are not speeding on the acquisition autobahn so far this year as fast in prior years, it is clear they are committed to insurance brokerage. Many so-called industry experts have previously predicted the ultimate demise of banks in insurance and point with great pride to the many "failed" attempts of banks entering insurance. While it is true that some banks may not have fared well in insurance distribution, leading banks in insurance brokerage continue to realize strong financial and operational performance.

Many banks view their insurance operation as an important element in improving non-interest income ratios and providing return on capital. Leading banks with comprehensive bank-insurance strategic plans and scalable foundation agencies with attainable cross-sell penetration rates are not backing away from insurance but are reaping the financial success of this profitable product offering and remain fully committed to the insurance industry.

Well-defined strategic plans that incorporate all operations, including those of the insurance segment, into the big picture by melding insurance and bank cultures, implementing an attainable cross-sell penetration rate, and rewarding contributors appropriately will remain committed to insurance brokerage and succeed in insurance distribution. Like Rome, Main Street wasn't built in a day.

Figure 1
Most Active Bank Acquirers 2000-2006

Notes:
¹Previously Community First Bankshares; BancWest Corp. acquired Community First Bankshares in November 2004. BancWest Corp. is a wholly owned subsidiary of BNP Paribas.
²Previously Banknorth Group; TD Bank Financial Group acquired Banknorth Group in February 2005.
³Previously Waypoint Financial Corp.; Sovereign Bancorp acquired Waypoint Financial Corp. in January 2005.

Figure 2
Top Bank Acquirers Through July 31