Snapshot for week beginning 6 June. In the low interest environment of the Covid-19 crisis, banks are increasingly hunting for activities that generate fee income, trading revenue, and other types of noninterest income.
The Covid-19 outbreak, associated lockdowns, and intensified risk aversion on the part of banks have started to weigh on their revenues, with non-interest income dropping for most lenders in the first quarter of 2021.
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Shrinking consumption hit credit card fees and lower originations and disbursements meant there was little to rake in, in the form of processing fees.
Traditionally, banks have generated most of their income by issuing loans and collecting the interest payments. However, a large fraction of bank revenue also comes from so-called “noninterest income,” which includes items such as overdraft fees and ATM charges.
The economic effect of the pandemic resulted in tightened credit standards and reduced demand for many types of loans.
In the face of very low interest rates during the pandemic, it might seem natural that banks would make greater use of noninterest income to make up for any declines they might be experiencing in interest income.
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By GlobalDataNoninterest revenue sources are positively related to performance but inversely related to risk.
The results are consistent with a beneficial diversification effect during the pandemic from banks expanding beyond traditional lending sources of revenue.
Banks with greater reliance on capital markets, asset and wealth management income streams will face deeper revenue losses in an adverse scenario over a one-year horizon.
Diversification as a double-edged sword
Assessing the short-term impact of the Covid-19 pandemic on revenue and profitability at the largest global investment banks, Moody’s analysts concluded that “more universally oriented, diversified banks” would be under less immediate revenue pressure.
Banks with greater reliance on capital markets, asset and wealth management income streams will face deeper revenue losses in an adverse scenario over a one-year horizon, the analysts said.
While a greater mix of assets and revenue streams may offer protection from large concentrated losses, wider networks could leave them more vulnerable to global shocks, consensus suggests.
Diversification as a shift from traditional revenue sources
The U.S. banking industry is steadily shifting away from traditional sources of revenue like loan-making and toward non-traditional activities that generate fee income, service charges, trading revenue, and other types of noninterest income.
This shift toward noninterest income has contributed to higher levels of bank revenue in recent years, but there is also a sense that it can lower the volatility of bank profit and revenue and reduce risk.
One potential channel is that noninterest income may be less dependent on overall business conditions than traditional interest income, so that an increased reliance on noninterest income reduces the cyclical variation in bank profits and revenue.
Alternatively, expanded product lines and cross-selling opportunities associated with growing noninterest income may offer traditional diversification benefits for a bank’s revenue portfolio.
Our featured deal this week is not about a bank, but rather a provider of pawn loans.
Deal the week: EZCORP Acquires 128 Pawn Stores in Mexico
EZCORP a provider of pawn transactions in the United States and Latin America, announced that it has acquired 128 pawn stores in Mexico.
The stores, operating under the name “Cash Apoyo Efectivo,” are principally located in the Mexico City metropolitan area and enjoy strong brand recognition in that market.
The acquisition is the company’s largest to date in terms of store-count. With this acquisition, the company now operates a total of 1,154 pawn stores, 638 (55%) of which are in Latin America, including 503 in Mexico.
The initial purchase price of $33.8m includes cash of $17.3m, 212,870 shares of the company’s Class A Non-Voting Common Stock valued at $1.6 million, and repayment of $14.9m of Cash Apoyo Efectivo’s existing debt.
The sellers will be entitled to additional payments of up to $4.6m over the next two years, contingent on the performance of the acquired stores.
Diversification and risk reduction
The ability to reduce risk is obviously a topic of considerable importance for individual banks, as well as their regulators and supervisors.
If noninterest income lowers the volatility of bank profits and reduces risk, for example, it might be reasonable to reduce capital requirements for banks with a diversified revenue portfolio and for supervisors to reallocate their scarce resources.
Similarly, the costs of bank supervision are tied to the perceived riskiness of the institution, so banks have additional incentives to reduce risk.
