Does fee income hedge banks and credit unions from spread swings?
The drum is starting to beat again for fee income in the minds of banking executives and in financial institution strategy sessions. This week I heard “hedge” against interest rate fluctuations, a comment more common in the late 1990’s to mid 2000’s. So I ran some numbers, and the answer to the post title is: it depends.
Fee income comes in many sources. And for most community banks, which I define as banks with less than $10 billion in assets, fee income comprises 10%-20% of total revenue, on average. See the table for a break down of fee income sources by Call Report category for community banks.
With all the talk about fee income lines of business, much if not most of our fee income comes as additional revenue from traditional spread products, such as deposits or residential mortgages. This makes sense. It is our primary business, and fees improve the profitability of bread and butter banking.
But what about this hedge philosophy? I was skeptical. I know from my company’s profitability measurement service that fee income products contributed 1% to profits at the average, and -0.8% at the median of all clients. Admittedly, this includes loss leader products such as safe deposit boxes. But, in the main, fee based products are not dropping much to the bottom line.
However, when I sorted top fee based banks and compared their Return on Average Assets to the industry, it appears as though having significant amounts of fee income does protect the institution from the ski slope decline in financial performance that plagued the industry. In effect, high levels of fee income gave financial institutions a softer landing at the bottom (see chart).
But if financial institutions want more from fee based lines of business than to soften their fall, they must focus on delivering profits. This has been a challenge. When I hear executives clamor over fee income, they more often than not focus on revenue generation, not profits. In my experience, profits have been elusive.
I hear lots of excuses why fee-based LOBs don’t make money: soft insurance market, best efforts execution on mortgages, stock market decline, high pay to keep talent, yadda, yadda, yadda. I once heard a complaint from a head of Trust about having to share the copier expense with another department that used said copier more.
Bottom Line: Insurance, Trust, Investment Advisory, Mortgage Banking, these are all businesses that are common sense complements to traditional spread banking. Almost all of bank customers demand these services.
Why can’t we deliver them profitably?