Community banks are cashing in on the commercial real estate boom in more ways than one.
Not only are they making more commercial real estate loans than ever, but they are also making inroads in the niche business of holding funds for real estate investors.
In recent years several banks have acquired companies that perform so-called 1031 tax-deferred exchange services, or they have developed these services in-house. In addition to generating fee income, the services can bring in a steady stream of low-cost deposits, said Daniel C. Stevens, the chief financial officer of the $3.3 billion-asset Taylor Capital Group Inc. in Rosemont, Ill.
"These are core deposits which are not only at a lower rate but, perhaps more importantly, are more stable" than other funding sources, such as brokered deposits, Mr. Stevens said.
The Internal Revenue Service lets companies or individuals that sell commercial or investment properties defer capital gains taxes if they reinvest in other properties within 180 days. To get the tax break, investors must use a qualified intermediary to process the paperwork and hold the funds until they are ready to buy another property.
In hopes of capturing these lucrative deposits, bank companies are buying these intermediaries.
Last month The Bank Holdings, a Reno company with $385 million of assets, bought Granite Exchange LLC, a Roosevelt, Calif., company it renamed Granite Exchange Inc. The unit now operates two exchange services, Granite Exchange Services and AllStar Exchange Services.
The $5.7 billion-asset Commercial Capital Bancorp Inc. in Irvine, Calif., has bought several exchange companies since early last year and has merged them into three subsidiaries. (The company announced this week that it was selling itself to Washington Mutual Inc. of Seattle.)
Taylor Capital's Cole Taylor Bank has been offering tax-deferred exchange services in-house since the 1970s. It liked the service so much that six years ago it expanded its operations to reach investors nationwide.
But the business has really taken off since the bank began a partnership in October with Nationwide Exchange Services Inc., a Cupertino, Calif., online provider of tax-deferred exchange services. Cole Taylor employees who brought in clients for the tax-deferred exchange service now work for NES, but Cole Taylor gets to keep all of the deposits they generate. Moreover, the bank gets fee income anytime it refers new customers to NES, though Mr. Stevens would not say how much.
Cole Taylor made the deal because it could attract more investors by helping market NES' new Web-based capabilities, he said. Since October the bank's deposits from the services have more than tripled, to about $300 million.
"This company came up with a phenomenal software program that makes it extremely easy for a company to do 1031 exchanges online, with all of the compliance bells and whistles," Mr. Stevens said. "We want to maintain our contact with the customers by keeping their deposits, and it's also helped us fund their growth."
Richard A. Soukup, a partner with the Chicago accounting and consulting firm Grant Thornton LLP, said tax-deferred exchange services not only can provide low-cost funding and fee income, but also enhance a bank's relationships with commercial customers.
"It's a good specialty business for a real estate-oriented bank, who can get a lot of leads," Mr. Soukup said. "They've already made a loan to a borrower who's flipping a property, and then banks can facilitate" that transaction "by warehousing their cash until they find another piece of property."
Like Cole Taylor, the $158 million-asset Christiana Bank and Trust Co. in Greenville, Del., has developed an in-house tax-deferred exchange service provider, Christiana Corporate Services Inc.
However, the company is less interested in low-cost deposits than generating fee income. Instead of putting investors' sale proceeds into low-cost deposit accounts, it invests the funds in higher-yielding instruments through the wealth management department, said Thomas A. Campbell, an executive vice president.
"This enables us to attract customers with much larger transactions, and that generates a lot of fee income for us," Mr. Campbell said.
Though he would not say how much Christiania charges for the service, he said it was a "substantial" part of his company's trust fee income, which rose about 15% in the first quarter from a year earlier, to $916,000.
Martin Verdick, a managing director in the Champaign, Ill., office of RSM Gladrey Inc., said banks considering offering tax-deferred exchange services should make sure they hire experienced people, because the IRS requires very specific procedures and documentation. If banks fail to adhere to all the rules, their customers could face huge tax liabilities - and they often can recoup by suing the bank, he said.
"It's not as simple as opening an account and holding the funds," Mr. Verdick said. "There are very strict requirements that have to be met, and banks need to be very careful."
Karen M. Meislahn, an assistant vice president and trust officer at Main Street Bank & Co., a unit of the $1.6 billion-asset Main Street Trust Inc. in Champaign, Ill., said it gets around those requirements by having the customers' attorneys do all the necessary paperwork. That way, the attorneys assume much of the liability, while Main Street maintains an average monthly balance of $1 million in each of the accounts for the service, she said.
Main Street opens about 40 to 50 such accounts a year, she said.
"We don't make a lot of money on these services, because we really just dump the money into an account, and the attorneys do all of the real work," Ms. Meislahn said. "But we do the service as a favor to these attorneys, who also come to us with clients who need estate planning and other trust services - and those fees are a lot better."
Last year Main Street's income from trust and brokerage fees increased 15%, $7.6 million.
