Non-Interest Income: Do You Have Enough in BOLI Investment?
By Eric Johnsen | June, 2015
"Despite some pleasant upside surprises, the current bank earnings season has been pretty unimpressive to date,” Joe Maloney, an analyst at Banks Street Partners, told SNL. Although year-over-year earnings growth looks fairly solid, a lot of banks’ first-quarter earnings failed to meaningfully beat their fourth-quarter 2014 numbers, he said. “There are timing and seasonality issues that could be at play, but one thing it suggests is that we’re entering a tougher growth environment,” Maloney said.1 The benefi ts of the credit quality recovery have been tapped out, loan growth remains difficult and persistent low interest rates continue to put pressure on margins.
So where can banks utilize alternative business strategies to help enhance their margins? One such area is non-interest income, specifically non- interest income generated from Bank Owned Life Insurance (BOLI). BOLI is a form of life insurance written on bank executives where banks retain the ownership and benefits associated with the policies, including tax-free death benefits. These universal life BOLI policies not only retain their original Cash Surrender Value (CSV) – the initial premium paid for the policy – but also earn non-interest income every month for the life of the policy. The bank remains the beneficiary of the policies for the life of the executive, even after they are no longer actively employed. Non-interest earnings are credited each month to the bank’s income statement, and the earnings in turn enhance the underlying cash surrender value of the life insurance policies on the balance sheet. Almost 70 percent of California banks have taken advantage of utilizing BOLI as a means of generating tax-deferred (and ultimately tax-free) non-interest earnings for the bank.
Banks are permitted to invest up to 25 percent of their Tier 1 capital in BOLI. Earnings from BOLI not only can boost the bank’s non-interest income earnings, but also have the effect of lowering the efficiency ratio of the bank, as well while offsetting expenses associated with non-qualified benefit programs and overall employee benefit programs. As the cash surrender value of the life insurance asset grows, this enhances the balance sheet, which in turn can be leveraged to grow and utilize capital for loans and other uses by the bank (up to multiples of 8-11 times for most banks).
Current yields on BOLI products are approximately 3.5 percent on a pre-tax basis (5.8 percent tax equivalent in 40 percent tax bracket). When one compares the earnings on a BOLI policy to a 10-year treasury rate, the performance is hard for a bank to ignore. With current yields of 10-year treasuries f loating around 1.9 percent on a pre-tax basis, and 1.14 percent after taxes at a tax rate of 40 percent, the crediting rates on BOLI makes it a very attractive investment for thebank’s overall portfolio. For example, a $5 million dollar investment in today’s environment will yield approximately $118,000 in additional annual earnings to the bank compared to the net yield of a 10-year treasury after taxes.
Earnings from BOLI not only can boost the bank’s non-interest income earnings, but also have the effect of lowering the efficiency ratio of the bank, as well while offsetting expenses associated with non-qualified benefit programs and overall employee benefit programs.
It is no surprise that nearly 70 percent of California banks and 60 percent nationally have utilized BOLI to take advantage of this unique investment profile. In addition to the attractive returns that BOLI can provide, BOLI is often used to finance executive benefit packages that help attract, reward and retain key executives. The BOLI life policy can help defray and in most cases completely offset the cost of executive non-qualified benefit expenses associated with SERPs, deferred compensation plans, healthcare premiums and other employee benefit expenses. Equally important, if an executive passes away while employed with the bank, the tax-free earnings from the death benefit of the BOLI policies will cover the accrued expenses associated with SERPs and other employee benefits that are owed to the beneficiary of the executive.
BOLI is really a win-win for the bank, both in terms of absolute returns as well as a key risk management tool for banks in the unfortunate event of the untimely passing of executives on whom BOLI policies are written. BOLI can be a formidable portfolio diversification tool for banks that may be over-concentrated in a particular sector of their loanportfolios, even for banks that may be nearing their loan capacity.
Eric Johnsen is executive benefits and BOLI consultant for Equias Alliance. He can be reached at (831) 373-4614 x1 or firstname.lastname@example.org.
1 SNL, “Bank & Thrift Daily,” April 22, 2015.