Magazine article American Banker

Financial Motives for Mixing Financial Services

Magazine article American Banker

Financial Motives for Mixing Financial Services

Article excerpt

Hardly a day goes by in the financial services arena without new reports of merger and acquisition activity among insurance companies, brokerage and investment houses, banks, and real estate concerns.

In addition, we are no longer startled to hear news of nonfinancial businesses like Sears, Roebuck and Co., Gulf and Western, or U.S. Steel jumping into the world of brokerage, real estate, and even banking.

The firms participating in this activity generally explain their actions as being driven by a desire to expand both their product lines and customer bases. Beyond these broad strategic objectives, however, the stated motives rarely get more specific. In fact, there seems to be a good deal of confusion in explaining the fast pace of evolution presently underway in the financial services sector.

In hopes of clearing up some of that confusion, we have compiled a few simple ratios on the financial characteristics of eleven major financial services industries. Examining these ratios across the various industries offers some useful and simplying insights into the potential motivations behind the changing corporate structures and product offerings of financial services providers.

The financial ratios we've computed are those commonly used by financial analysts to investigate the sources of a firm's (or in this case an industry's) return on equity capital. These ratios measure profit margin, asset turnover, return on assets, and financial leverage.

Taken together, the industry ratios offer the reader a powerful tool for examining developments in the financial services arena. They not only provide a greater understanding of the recent financial characteristics of each industry but can be used to illustrate the relative attractiveness of combining different financial services and institutions.

The combination of different services (real estate brokerage and commercial banking, for example) can be modeled on an aggregate basis by combining a financial characteristics of one industry (return on assets, perhaps) with a characteristic of another (i.e., financial leverage).

This modeling process can be conducted for a wide range of potential combinations. Of course, real world constraints would prevent specific combinations from actually achieving the results implied by such a modeling procedure. Nevertheless, analysis of these industry ratios does illustrate the general form of potential benefits that might be achieved by combining different financial services under various corporate structures.

The accompanying chart presents our financial ratios by industry. They were developed using 1982 industry data on revenues, after-tax profits, and the book value of both total assets and equity capital for each of 11 different financial services industries. Those 11 include commercial banks, mutual savings banks, savings and loan associations, credit unions, securities firms, investment management companies, life insurance companies, property/casualty insurance companies, real estate brokerage firms, mortgage banks, and finance companies.

The general insights obtained from analyzing this 1982 snapshot are not significantly different from those obtained using historical trends. While the specific numbers have changed from year to year, the relative rankings of individual industries for each ratio using 1982 data closely approximate the rankings obtained using five-year historical averages.

The best way to examine the returns on equity of these industries is in the order in which the ratios are presented in the accompanying chart. A comparison of the returns on equity themselves gives a general overview of the relative attractiveness of the various industries.

With this overview, an investigation into the sources of the industry returns on equity can be conducted. This is accomplished by first examining industry profit margins and asset turnover rates, both individually and in the context of how they combine to determine an industry's return on assets. …

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