Question

Royal Financial Services (RFS) provides front end loan origination services for a number of banks who...

Royal Financial Services (RFS) provides front end loan origination services for a number of banks who process and maintain loan portfolios. RFS accepts applications from customers and processes them through closing of the loan agreement before turning the loan over to customer banks. RFS is paid regardless of whether the loan closes or not. RFS currently services three types of loans - residential mortgages, auto loans, and personal unsecured loans. RFS has no cost accounting system so total operating expenses are simply allocated to each product line based on revenue.

For the year just ended, RFS reported financial results as follows:

Income Statement

Mortgage

Auto

Personal

Total

Annual Volume of Loans

1500

6000

4000

11500

Origination Fee/Unit

$350

$200

$115

Total Revenues

       $525,000

    $1,200,000

$460,000

$   2,185,000

Operating Expense

       $504,673

    $1,153,538

              $442,189

$   2,100,400

Profit

$ 20,327

$ 46,462

$ 17,811

$   84,600

Profit % Revenue

3.9%

3.9%

3.9%

3.9%

RFS management is concerned about the overall low profitability of the business and has asked you to apply activity-based analysis in order to give RFS a better understanding of relative product profitability. After extensive interviewing of staff and analysis of RFS’s cost structure, you determine there are four primary activities that RFS performs, with cost drivers and total cost as follows:

Activities

Activity Driver

Mortgage

Auto

Personal

Total Cost

Accept applications

# pages per application

4

3

1

616,000

Obtain credit referrals

# credit sources/applic.

2

2

1

332,500

Do loan analysis

# hours analysis/applic.

3

2

1

656,000

Close loan

# hours to close loan

4

2

1

495,900

You determine that the application processing and loan analysis activities are performed using internal RFS resources while the credit and closing activities are performed primarily by external credit agencies and law offices on a per transaction basis (e.g. $X per credit check, $Y per closing hour). You also learn 70% of the mortgages end up being closed (the remainder are not approved after loan analysis); 80% of auto loans close and 90% of personal loans close.

You also identify a key external measure of how well RFS is performing versus the industry. While RFS does not bear the cost of defaults, their customers do track RFS performance and use it to negotiate future origination fee rates.

Mortgage

Auto

Personal

Default rate experienced by loan processor

2%

1%

6%

Industry average

2%

3%

4%

Based on the above information, use activity-based costing to assess the total and per unit profitability of RFS’s three loan products

Write a brief memo (maximum 1 page, double spaced, font 12) to RFS management summarizing the results of your analyses. Make specific recommendations to RFS to improve business profitability.

Homework Answers

Answer #1

From Above analysis, we can see that Mortgage loan is making loss around 100%. Wheare as other loans are generating modarate profit.
Mortgage loan is reducing agregating profitabilty of the bank.
There is huge operating cost of Mortgage loan. Its revenue per unit is much less than its operating cost per unit.
The cost rate of loan analysis is huge.

A suggestion could be-
Bank should increase its mortgage price per unit
It should control mortgage defult
Bank shold check external rate of loan analysis. If its low outside, the they should do it externally.
Or they sholud close mortgage unit

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