Inside Your Banker’s Head

Companies are starting to figure out how their banks make money. Banks actually like that.

Not every service can be measured. For example, Edward Jones offers a company-branded credit card to its clients through MBNA Corp. “I frankly don’t know how to assess the profitability of that,” he admits. But with a few such exceptions, Schutte attempts to capture all of the business done with each bank — right down to the fees Edward Jones pays for the three ATM machines on its campus.

In most cases, he says, the information isn’t hard to collect. “For short-term loans,” he says, “we know the outstandings we’ve had with each bank, we can estimate how many days so we can get an average outstanding per borrowed day, and we know the spread they’ve been charging.” That’s enough to estimate the banks’ net interest income. Similar information is available for other types of loans, as well as for short-term investments, he says.

Likewise, Schutte tracks treasury fees such as cash management and fees for banks that act as collateral agents or trustees on bond issues. “We capture as many of those types of fees as we can,” he says. To calculate each bank’s pretax net income from fees, he says, “we then apply the [overhead] efficiency ratio that is published in their financial statements.” (Schutte makes an exception for banks with excessively high ratios, instead applying the average ratio for Edward Jones’s full bank group. “We don’t reward any bank for being inefficient,” he explains.)

Finally, Schutte totals up fee and interest income and subtracts taxes — based on the tax rate that the banks report in their financial statements. “That gives us our best guess at their after-tax net income figure for Edward Jones,” he says.

Large one-time capital-market fees for services such as private placements — which Edward Jones does every few years — are spread over a similar interval. “The bank that does the private placement gets a pretty significant fee,” he explains. “We allocate that over the interval so they don’t have such a volatility in their earnings and return calculations.”

To calculate the bank’s return on assets (ROA) for his firm, Schutte divides the total net income for each bank by the average assets Edward Jones has placed with that bank. He also calculates a return on equity (ROE) using an assumed capital requirement of 8 percent. That’s the amount of capital banks must set aside under international regulations known as Basel I. “We don’t try to determine what their individual equity ratio is,” he says.

Schutte ran early results of his model past some of his bankers several years ago and made only minor tweaks based on their feedback. “For the most part, we were in the ballpark,” he says. “It is an art on our side, but it’s still an art on their side, too.”

Schutte compares the ROA and ROE figures to the ratios published in each bank’s annual report to get a sense of how valuable Edward Jones’s relationship is to each bank. “If we are significantly below where they are, then we conclude that we are deemed not sufficiently profitable. And if we are significantly above, we conclude we must be significantly profitable.” He says he has used the model only once to move business from one bank to another, but he uses it regularly to award incremental business. “We’re not trying to wring the last nickel out of our bank relationships; we are trying to ensure that our relationships are profitable to them so that we can rely on them being credit providers,” Schutte says.

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