When it comes to boosting fee income, the adage "no pain no gain" seems appropriate for community banks.

Smaller institutions have historically struggled with noninterest income, which made up roughly a quarter of total revenue last year at banks with assets of $10 billion or less. Regulation has cut into some charges tied to deposit accounts, while a drop in refinancing activity due to rising interest rates has also taken a toll.

While that has forced some community banks to find new revenue sources, doing so can take considerable time; it also comes with some level of risk.

Take NBT Bancorp in Norwich, N.Y., for example. The $9.1 billion-asset company has successfully built a business that provides back-office administration and recordkeeping services for entities that manage retirement plans. Still, it took the company more than a decade to get to where it is today.

The move was necessary given the pressure banks face in their traditional lending operations, said Timothy Brenner, NBT's president of wealth management.

“If you want to take your bank to the next level up, you have to realize that ... margins between loans and deposits will continue to be challenged,” Brenner said. “We're back to needing a diversity of income within the bank.”

A closer look at noninterest income shows a widening gap between small banks and larger competitors.

Total noninterest income at banks below the $10 billion asset threshold fell about 1% in 2017 from a year earlier, to $34.8 billion, according to data from the Federal Deposit Insurance Corp. In contrast, noninterest income at banks above that threshold increased by roughly 1%, to $220.6 billion, making up more than 35% of revenue.

“The smaller the bank, the harder it is to be successful in fee income,” said Robert Kafafian, president and CEO of Kafafian Group. “Unlike traditional spread-based business lines in most financial institutions, fee-based businesses require scale to be profitable.”

Many traditional fee businesses, such as wealth management, may not be very profitable for community banks, said Alexander Twerdahl, an analyst at Sandler O’Neill. Still, banks may choose to offer such services because they require little capital investment and offer cross-selling opportunities into other, profitable products and services.

“The average community bank is breaking even” on some fee businesses, Kafafian said. “The majority of them don’t have the scale.”

It took years, and a series of acquisitions, for NBT to build up its business.

The effort began in 2005 when NBT bought Epic Advisors, a recordkeeping firm it had been working with, Brenner said.

Since then, it has bought companies that provide third-party administration, retirement plan consulting and actuarial services. Earlier this month it bought Retirement Plan Services, which provides recordkeeping and plan design products to employers.

With these acquisitions, NBT has the ability to provide more services across a national network, Brenner said.

The company, which also offers insurance and wealth management services, recently reported that its noninterest income rose 5% in 2017 from a year earlier, to $121.3 million. Fee income made up roughly 30% of NBT’s revenue last year.

The retirement planning business has been a “nice contributor to fee income” at NBT, Twerdahl said.

Still, developing an atypical niche can be difficult for community banks, especially with fintech firms “looking at every aspect of financial services and how they could digitize it,” said Tom Hall, president of consulting firm Resurgent Performance. Banks also need “considerable expertise and knowledge” in a desired niche to succeed, he added.

Regulations, particularly those that are unfamiliar to traditional banks, can create potential landmines, industry observers said.

NBT management must be mindful of the Employee Retirement Income Security Act of 1974, or Erisa, because violating it can lead to hefty fines, said Matthew Schultheis, an analyst Boenning & Scattergood.

Those concerns are unlikely to keep many community banks from trying to find ways to reduce their reliance on spread income.

“Banks will continue to look for avenues to enhance their fee income,” Schultheis said. “What we will find is that small banks usually get in a business and grow that business as they grow. They have an opportunity to have a meaningful impact on them.”

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