Banks are navigating a challenging and unprecedented banking environment due to the impacts of COVID-19. Interest rates are low, businesses around the country are not fully operational, and banks are facing potential loan losses. However, banks are still expected to make strategic investments to continue to produce strong earnings while evaluating the risk of those underlying investments.
During this challenging economic landscape, Bank Owned Life Insurance (BOLI) remains an asset banks should consider due to the consistent income produced by BOLI policies through high credit quality insurance companies.
The banking industry as a whole came into this crisis with high capital levels, strong loan demand, strong earnings growth, minimal loan losses and high profitability. With banks in a strong financial position, they are well positioned to weather the economic storm. However, it is clear that they are expecting loan losses, as evidenced by the recent increases in loan loss reserves in Q1 2020.¹ The severity of those losses will play out over the next six to twelve months, but it will take several months to fully analyze the initial and ongoing impact of COVID- 19 on bank balance sheets and loan portfolios. The impact will likely vary based on geographic footprint, sector allocations, asset quality, underwriting practices, and several other factors.
In late March, banks found some relief administering the Paycheck Protection Program (PPP). Many bankers found this program to be an attractive opportunity to generate fee- based revenue with relatively low risk. Under the PPP, banks offer federally guaranteed loans to small businesses, with amounts used for payroll and other expenses convertible into a grant. The loans carry an interest rate of 1%, and banks receive a fee of 1% to 5% depending on the amount of the loan.² However, with the PPP loans funded, banks will need to look at alternative ways to increase earnings for the bank.
The BOLI industry had a strong first quarter of 2020 with over $640M of new BOLI purchased.³ Although the landscape has shifted due to COVID-19, BOLI is still attractive in today’s marketplace. Most BOLI carriers are large diversified insurance companies with financial strength ratings of AA and above by S & P. Insurance companies have sophisticated investment teams with vast resources that allow them to take advantage of opportunities in the market and provide increased performance. In a new BOLI transaction, banks have the ability to invest with an insurance company that has established portfolios with longer dated, higher yielding assets. Banks can expect cash on cash yields of around 3% with tax equivalent yields in the 4% range, depending on tax rate.4 When invested in General Account BOLI, the mark-to-market risk is borne by the insurance carrier and the insurance companies provide guaranteed minimum crediting rates.
Some carriers have taken advantage of recent spread widening and purchased assets, which now support the ~ 4% tax equivalent yields noted above. This presents banks with an attractive high credit/high yield alternative to loans and other bank eligible assets.
For additional information, contact Justin Robertson, Senior BOLI Consultant or Scott Bethune, Vice President BOLI Consulting at (336) 333- 2050.
¹ FDIC Call Reports
² S&P Global – Market Intelligence
4Insurance Carrier monthly rate sheets
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