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.
That experience has led many to wrestle with the idea of quitting.
In the case of Farmers and Merchants Bank and Trust Co. Inc. in Burlington, Iowa, that moment came five years ago.
"It had reached the point where we couldn't justify the salaries with the commissions the business was creating," said John Wagner, the senior trust officer of Farmers and Merchants' trust business.
The company opted to stay in the business and instead focused on getting wealth management in closer alignment with its banking strategy.
It was a decision that at the time ran contrary to trend. But times, market conditions, and perspectives have changed and asset management has come back into vogue at small banks.
"With markets in a tizzy, smaller banks are interested in using asset management as a profit generator to diversify their revenue streams," said William W. Reid Jr., the president and chief executive of ICBA Financial Services, the investment management arm of the Independent Community Bankers of America. "They have learned over the past five years, that if they are creative, they can be successful."
Richard Ayotte, the chief executive officer at American Brokerage Consultants Inc. in St. Petersburg, Fla., said small banks have refined their product lineups, used outsourcers, and examined their businesses to determine the best way to profit from wealth management.
He said that this process can take time, since smaller institutions do not have much margin for error, but the result has been a higher percentage of smaller banks offering, and profiting from, wealth management.
"The notion that small banks are getting out of wealth management is simply not true," Mr. Ayotte said. "It can be a tough sell to get a small bank into wealth management, but once they get in, they rarely get out. It is a real generator of profitability."
Marc Pershan, an executive vice president and director of private banking at New Century Bank in Chicago, agreed.
"In the world today, small banks can't survive on margin interest income alone," he said. "The costs of deposits are high, loans rates are coming down, and banks are being squeezed. Banks our size can either nickel-and-dime clients with pain-in-the-neck fees that clients don't like, or develop sustainable businesses that aren't tied to spread incomes."
Executives at companies like Susquehanna Bancshares Inc. in Lititz, Pa., and Washington Trust Bancorp Inc. in Westerly, R.I., are among those that say a focus on wealth management has made a critical difference in the current market.
Susquehanna said it expects fee-based assets to exceed its $13 billion of total assets within the next five years, and Washington Trust, which has bank assets of $2.4 billion, said it aims to double assets under management to $10 billion in the next three to five years.
New Century, which generates 70% of its business from real estate developers, has offered wealth management services since opening its doors in March 1999. At first it tried selling asset management services through a stand-alone subsidiary, Ontario Street Investments, but "this model provided unsatisfactory results," Mr. Pershan said. At its high point Ontario Street had only $20 million of assets under management.
Mr. Pershan said its wealth management business "stubbed its toe" and had a lot "failures before we established things that really worked."
The $435 million-asset New Century sold Ontario Street in 2002 and moved the asset management business into the bank. From 2002 through 2003 the bank licensed platform reps to sell its investment management products and services, but real estate developers "weren't receptive to asset management," Mr. Pershan said.
New Century did not generate assets with wealth management until July 2007, when it bought the private-equity firm Chicago Investment Group. Mr. Pershan said real estate developers were interested in buying private-equity products even though they were not keen on traditional investment offerings.
Joseph S. Babyak, senior vice president of the investment division at the $391.9 million-asset Sussex Bancorp in Franklin, N.J., said Sussex is cross-selling wealth management services to its customers. The investment unit, which has $400 million of assets under management, is not profitable yet, but Mr. Babyak said he plans to hire more people to improve margins.
"We are targeting our customers who already have a loyalty to this bank," he said. "We'll lose a customer once in a while to Merrill Lynch or Smith Barney, but most times, our customers don't have the resources to fit the minimums that the wire houses are interested in."
Mr. Pershan said New Century does not target its own customers. When it 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 said. Eighty percent of Chicago Investment's customers, accounting for $35 million in assets under management, do not bank with New Century.
"They haven't come over here for that yet," Mr. Pershan said. "They are loyal to their broker and we hope eventually they'll come to bank with us. Twenty percent have come so far, and that is great. We want to become more symbiotic as we grow."
But one size does not fit all. Mr. Wagner said the $217 million-asset Farmers and Merchants needed to create a brokerage business, integrate it with its trust business, and tie both closer to the parent bank to add assets.
"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," he said. "We needed to bring ourselves closer to the bank downstairs."
In 2005, Farmers and Merchants it started a brokerage arm, Four Points Financial, to serve the bank's customers. After some growing pains, both units have grown. Farmers and Merchants ended 2007 with $95.5 million of trust assets and $25.6 million of brokerage assets. Its brokerage assets more than doubled, adding 213 new accounts.
"These are businesses that the bank had to have," Mr. Wagner said. "We are looking at this as a real profit center for the bank now."
Michael Schwenker, a financial consultant at Four Points, said small banks that do not offer asset management risk losing customers. "If deposits go from the bank to our brokerage business, then they might go back to the bank at some point, but if that money goes down the street to Edward Jones, I doubt that money will march back up the street in nine months," he said.
Michael A. White, the president of Michael White Associates LLC in Radnor, Pa., said that 22.5% of banks with assets below $4 billion reported third-quarter fee income. He said that this number has remained "between 20% and 25" over the past decade despite consolidation.
Small banks tallied $129.76 million of fee income in the third quarter, up 0.03% from the previous quarter. Mr. White said these numbers were generally positive considering large banks did not post a quarter-to-quarter rise in fee income. "It is a big mistake if a community bank isn't in this business," he said. "Some don't think that they have the resources to succeed, but these resources can be acquired or provided."
Many small banks have signed on with turnkey asset managers such as Placemark Investments Inc., of Dallas and Wellesley, Mass., or FundQuest Inc. of Boston, a unit of BNP Paribas SA, to build wealth platforms.
Others are pursuing acquisitions to generate fee revenue. TIB Financial Corp. in Naples, Fla., announced in December that it was buying Naples Capital Advisors, which had $80 million of assets under management.
"We needed broader opportunities in order to develop our revenue stream," said Millard Yonkers, the executive vice president of the $1.4 billion-asset TIB. "We saw this as an ideal opportunity to improve services. We believe this will add considerably to our bottom line."
