It isn't easy being small. While the big regional and national banks can support their reps through a transition to fees, the margins at community banks are shaved closer to the bone. Yet for many program managers and advisors, there are compelling reasons to go "feeward."
First of all, banks need new sources of recurring revenue now more than ever. "With interest rates headed down plus the squeeze on margins, community banks are looking to improve revenue and this is the way to do it," says Bill Reid, president and chief executive of ICBA Financial Services, the third-party marketer arm of the Independent Community Bankers of America.
Also, high-net-worth customers favor fee-based accounts. Ongoing payments, after all, must be justified with ongoing service, which in an advisory sense means a perpetually evolving financial plan. This works for the client since their finances are never left to atrophy, and it opens up opportunities for the bank to continue to cross-sell its services. Says Matt Jacob, vice president and chief investment officer at Solvay Bank in Solvay, N.Y.: "There's a big difference between 'customer' and 'client.' Banks have customers who buy once, but clients buy for a lifetime."
Cost and complexity once made it impossible for small-fry to tackle the advisory business, but once asset management and third-party marketing firms began offering turnkey solutions, banks could hire in packaged advisory services and offer them under the banks' own labels.
Nonetheless, it's still tough to get into the wealth management business. It can take bank reps years to build up significant revenue from assets under management, and they have to forgo short-term transaction commissions for the promise of a longer-term relationship gain. This is something they are understandably reluctant to do. As such, asset management has often cast small banks in the role of Tantalus—the fee income it represents is exactly what they need, but the returns stay stubbornly out of reach.
Fear of Flying
Many small banks simply haven't bothered to try to get into the business. Only 22.5% of banks with assets below $4 billion reported third-quarter fee earnings, according to Michael White, the president of consulting firm Michael White Associates in Radnor, Pa.
Others have had so much trouble finding a fee-based business model that fits, they give up. But some small banks have taken the leap, and sometimes through trial and error, sometimes through acquisition, struck on a model that works. Managers who do so in the face of obstacles usually realize that there is a bigger threat to their business down the line if they don't. "Banks our size can either nickel-and-dime clients with pain-in-the-neck fees, or they can develop sustainable businesses that aren't tied to spread incomes," says Marc Pershan, an executive vice president and director of private banking at New Century Bank in Chicago. It also requires a passion for greater service and a sense that deeper relationships—rather than commissions—are the wave of the future. "Community banks that have been successful have done so through the belief that fee accounts represent a better service to their customers," ICBA's Reid says. "The end result improves their performance with recurring revenue." White is even more emphatic: "It's a big mistake if a community bank isn't in this business."
Farmers and Merchants Bank and Trust in Burlington, Ia., almost gave up in 2002, when it merged with smaller local competitor West Burlington Bank, which had a flagging full-service brokerage. F&M had a slowly growing trust department, started back in the 1960s.While the bank was satisfied with the trust's slow progress, "it had reached the point where we couldn't justify the compensation with the commissions from the brokerage business," says John Wagner, F&M's senior trust officer. The brokerage had only one rep, who had never done more than $50,000 a year in commissions. "The first year with us, brokerage did even worse, and the board of directors discussed shutting it down," Wagner says. "I told the board that it was important to the bank, as it would translate into future trust and loan business, and convinced them to give it a chance."
Breaking Down Barriers
To increase assets, Wagner was convinced that F&M, with $217 million in assets, needed to create a brokerage business, integrate it with its trust business and tie both closer to the parent bank. Wagner set about aligning brokerage more closely with trust. "I started doing research, went to industry conferences and talked to as many people as I could about integration," he says. "Through those conversations I came to the conclusion that the question isn't how, but who you get involved." Wagner replaced the previous broker with a new one, Michael Schwenker, who was eager to work with the trust officers and willing to be paid as they are—a salary plus bonuses on group goals. In 2005, brokerage and trust were relocated to the same place at bank headquarters under the new name of Integrated Financial Resources. "When I started here in 1990, to get to the trust unit, you needed to get on an elevator at the bank, go up to the fifth floor, go through two glass doors and down a hallway to the trust officer," Wagner says. "We needed to bring ourselves closer to the bank downstairs."
F&M ended 2007 with $95.5 million in trust assets and $25.6 million in brokerage assets. But its brokerage assets grew faster, more than doubling by adding 213 new accounts. "These are businesses that the bank had to have," Wagner says. "We are looking at this as a real profit center for the bank now."
Although advisory revenue is only 10% of overall brokerage revenue, everything's already fee-based in the trust business. "As we move forward, I expect more and more fee revenue from brokerage," Wagner says. "Having reps on salary will allow that transition to occur without them taking a hit to their income."
Many accounts are too small to migrate to fees, so the brokerage side will continue to collect some commissions, Wagner says. "I know some programs are trying to go 100% fee-based, but on a $50,000 account we'd only make $600 a year, which is very difficult to maintain." Still, generating fee business will remain a core goal for the group.
As with F&M, advisory offerings at most small banks are so new that their performance has yet to pay off in a big way. Small banks tallied $129.76 million in fee income in the third quarter, up 0.03% from the previous quarter, according to Michael White Associates. Although a meager increase, these numbers were generally positive, considering that large banks didn't post any quarter-to-quarter rise in fee income, White says.
Community banks' key advantage over larger banks is that they have traditionally focused on service rather than sales, and fee business is a natural fit with a service culture, says Reid. But it's a slow process. A brokerage program takes a year to 18 months to meet any level of maturity. And a fee-based advisory business takes even longer to reach a critical mass, he says. To support the advisory division while it's growing, bank executives have to integrate them with other businesses areas, such as loans, in part so brokerage revenues won't seem so meager. But more important, investment services can boost commercial, loan and insurance businesses (see "Get Relevant," page 43). And increasingly, program managers at small banks have developed other innovative ways to keep advisory services growing. "They have learned over the past five years that if they are creative, they can be successful," says Reid.
If At First You Don't Succeed
New Century Bank in Chicago, which generates 70% of its business from real-estate developers, has tried offering wealth management services since opening its doors in March 1999. But the business "stubbed its toe" and had a lot of "failures before we established things that really worked," says Pershan. At first, the bank tried selling asset management services through a standalone subsidiary, Ontario Street Investments. But at its high point, Ontario Street had only $20 million in assets under management.
New Century, which has $434 million in assets, sold Ontario in 2002 and moved the asset management business into the bank, licensing platform reps to sell its products and services. But real estate developers "weren't receptive to asset management," either in or outside the bank, says Pershan. Most customers would rather buy commoditized products, such as mutual funds and annuities, at the cheapest price through a discount broker.
Finally, New Century stumbled on an investment product that resonated with its core clientele when a client asked to invest in private equity. Pershan put a two-man team to the task of sourcing opportunities for the client. This investment appealed to other developers-enough for the bank to buy a private equity firm, Chicago Investment Group in 2007.
Pershan had earlier teamed up with two regional broker-dealers, Broadmark in Seattle and Brewer in Chicago, and has been using seven of their reps who work independently outside the bank to develop a full-fledged advisory business. Pershan wants to combine the private equity subsidiary and wealth management groups under New Century's aegis. He expects FINRA approval to be granted in June.
While fee business makes up only 4% of overall wealth management revenue, Pershan expects it to grow dramatically, "with private equity as the carrot." Pershan's goal is aggressive—he wants the new unit to reach $5 million in revenue in five years, much of it from fees. He anticipates that 50% of the new unit's business will come from private equity sales, but hopes that the new business will soon get more than 25% of its business that it gets from bank referrals now. "They are loyal to their broker, and we hope eventually they'll come to bank with us."
Likewise, while 20% of the bank's clients, accounting for $35 million assets under management, invest with the private equity subsidiary, there aren't any clients coming the other way. "They haven't come over here for banking yet," Pershan says.
For the time being, Pershan doesn't expect referrals from the private equity group. Indeed, when the bank first acquired Chicago Investment Group, it bought office space across the street for it instead of setting it up in New Century bank branches. "You can't just pound on your customer base to sell more products," he says. However, "We want to become more symbiotic as we grow, and the private equity/advisory unit will become a true unit of the bank."
Jump-Starting Fee Revenue
Some banks have tried to avoid such growth pangs by making acquisitions that will generate fee revenue. TIB Financial Corp. in Naples, Fla., announced in December that it was buying Naples Capital Advisors, which had $80 million in fee-based assets under management. "We needed broader opportunities in order to develop our revenue stream," says Millard Yonkers, the executive vice president of TIB, which has $1.4 billion in assets. "We saw this as an ideal opportunity to improve services and believe it will add considerably to our bottom line."
Lana Burkhardt, director of marketing and sales coordination for wealth management at Susquehanna Bancshares Inc. in Lititz, Pa., would agree. Susquehanna has grown its fee business through acquisition, buying Valley Forge Wealth Management in 2003 and Widmannsiff last summer. In April, it will add Stratton Management to its stable, increasing its fee-based assets from $6 billion to $9 billion. "It's very difficult to grow this business organically, so our strategy is to acquire our way in," says Burkhardt."It's a quick way to jump-start fee revenue." Susquehanna expects fee-based assets to exceed its $13 billion in total assets over the next five years.
Following the Leader
Executives at Solvay Bank had the same idea on a much smaller scale. When a bank executive met Matthew Jacob on the golf course, Jacob had been an independent advisor for 25 years, with half of his $30 million book in fees. Jacob was being courted by Smith Barney to take over a territory in the Los Angeles area, but he didn't particularly want to move. After Jacob talked with Solvay executives about how larger firms were growing their businesses through advisory accounts, executives at the $500 million bank offered to buy his business and use him to launch its fledgling brokerage.
Jacob started off as Solvay's sole broker, licensed through his broker-dealer of 10 years, Syracuse, N.Y.-based Cadaret Grant. The bank teamed him up with its head trust officer to break down any potential silos between the two businesses. The trust officer, who had been at the unit since its inception, took umbrage and left the bank, and the bank asked Jacob to take over his position.
Over the next three years, Jacob continued to work his own book as well as head up wealth management and trust. He increased his percentage of fee income to 75% and hired three new advisors, who work closely with the three existing trust officers. Clients are directed to trust or brokerage depending on their needs, and many work with both. "If it's the same division as opposed to different silos, there's no internal fighting," Jacob says. Most of the clients must have around $200,000 to justify fees. "My business model was to build a recurring income program," he says. "We had the luxury of starting out that way."
In the three short years since Jacob came to Solvay, his unit has doubled the bank's number of advisory clients to 450 and trust clients to 800. The brokerage program grossed $488,000 last year, and Jacob is predicting a steady 20% growth rate. The advisory practice already manages $45 million in assets, compared with $135 for the 13-year-old trust department.
Just having one advisor focus on fees can make a huge difference. Fees now make up 20% of investment revenue at Columbia State Bank in Tacoma, Wash., in large part due to the efforts Margi Legowik. She joined the bank five years ago to work exclusively with high-net-worth clients, who are mostly small-business owners. "We had early success, attracting several multimillion-dollar accounts, so we had a significant early revenue stream. The market was favorable, and we had a nice buildup in assets," says her boss, Dean McSweeney, senior vice president and program manager for Primevest at the $3 billion bank.
Legowik's success with a mostly fee-based book has attracted the attention of the six other advisors at the bank who want to emulate the top producer. Of course, they will suffer a loss of immediate transaction income. But the payout should help ease the transition because it's higher. Whereas transaction sales are credited to advisors' standard production grid, fee accounts pay out at the highest level of 40%. "While advisors don't get the immediate payout, they're paid at the highest threshold every quarter," McSweeney says.
Advisory business is one of Columbia State's strategic initiatives for 2008 and beyond, says McSweeney, who has projected a 50% revenue growth in his unit's advisory business per year. "I'm adamant and passionate about this being the way to do business, especially with the high net worth," he says. "Plenty of other firms use this model, so in order to compete we have to be effective in the advisory market." New business primarily comes from referrals from commercial and private bankers and from existing clients based on their portfolio success, McSweeney says. "We frequently hold seminars and invite private bankers to bring a couple of their clients."
Fee business can also protect smaller banks from the risk of losing business to the competition, a problem all banks are wrestling with in the advisory business—especially the smaller fry. "If deposits go from the bank to our brokerage business, then they might go back to the bank at some point," says Schwenker, the financial consultant hired by Pershan at Four Points. "But if that money goes down the street to Edward Jones, I doubt that money will march back up the street in nine months." In broader terms, it can't just be a commodity business anymore, says Pershan, "Clients are more sophisticated now and they can make a trade for $9 at some places, but advisory services bring intelligent planning to the table, not just a transaction."
Small banks have refined their product lineups, used outsourcers, and examined their businesses to determine the best way to profit from wealth management, says Richard Ayotte, chief executive officer at American Brokerage Consultants in St. Petersburg, Fla. It can be a tough sell to get a small bank into wealth management, says Ayotte. "But once they get in, they rarely get out. It is a real generator of profitability." As clients' wealth in advisory accounts grows, so does the bank's revenue from fees. This virtuous cycle has led to a greater number of small banks offering-and profiting from—wealth management.
