By Laura Alix
While asset quality is improving and the number of problem banks has continued to decline, the recent increase in banking industry earnings is less because of robust loan demand and more the result of cutting costs.
Though net interest income increased $2 billion, or 1.9 percent, in the second quarter this year, non-interest income fell $3.6 billion, or 5.3 percent, across the industry in the second quarter, according to the Federal Deposit Insurance Corp.’s most recent quarterly banking profile.
A similar dynamic was at work beyond the very biggest money centers. Community banks increased their net income $166 million, or 3.5 percent, to $4.9 billion, but saw non-interest income fall $475 million, or 9 percent, from the year-ago period.
Some of that is down to a decline in mortgage banking income. The FDIC recorded a $3.7 billion decline in sales, securitization and servicing of one- to four-family homes and also noted that trading income declined for a fourth consecutive quarter, falling $721 million, or 10.1 percent, industry-wide.
But for many community banks, the Dodd-Frank Act also took a bite out of overdraft fee income, and while some have reacted by eliminating fee-free checking accounts, Ron Shevlin, a senior analyst at Aite Group, said the income generated by those monthly fees has apparently not been enough to counterbalance the decline in overdraft income.
Don’t forget the Durbin Amendment, either, which capped how much banks could charge on interchange fees, thereby putting a dent in non-interest income for many banks.
“If those numbers are still coming down, what it’s saying is that the increase in card volume is simply not making up for the decline in non-interest income generated through interchange,” Shevlin said.
A Balancing Act
With non-interest revenues declining, mortgage demand still soft and commercial lending ultra-competitive, that means banks are caught in a kind of balancing act of trying to increase revenue while also managing expense creep, said Matt Pieniazek, president of Darling Consulting Group in Newburyport.
“A lot of banks are looking at the additional compliance costs associated with Dodd-Frank and just deciding at this juncture that they’re going to pull back and cover their reduction in revenue by reducing other costs,” he said. For instance, some banks are cutting staff, revisiting branch strategy or getting out of the mortgage business altogether.
On the other hand, Pieniazek said he’s observed a smaller number of banks that have reacted by ramping up their mortgage lending efforts, recruiting third-party originators or agents in the hopes of casting a wider net beyond their pre-existing market area.
Still others have gotten more aggressive on loan pricing, in particular for jumbo mortgages and commercial loans, with risk-adjusted pricing on commercial loans now nearly as aggressive as it was pre-crisis, he said.
Some banks can rely on non-interest income from other sources, like wealth management services for wealthier clients. For instance, Independent Bank Corp., the parent of Rockland Trust, saw a nearly 18 percent year-over-year increase in its investment management income in the second quarter, even as its total non-interest income barely budged from the year-ago period.
However, services like wealth management and trust departments are very much volume-driven business lines, Pieniazek said. More commonly, increasing margin pressures are driving banks to take a harder look at their expenses, and that can mean reducing personnel, rank-ordering branches from most to least profitable, and more generally, trying to do more with less.
‘The $64 Billion Question’
That’s reflected in the FDIC data, which indicate that the increase in earnings during the second quarter was more the result of cutting costs than of any boom in loan demand.
So how might an industry struggling with increasing regulatory demands and razor-thin margins generate non-interest income, without alienating its customer base?
“That’s not just the $64,000 question. That’s the $64 billion question,” Shevlin said.
While qualifying that he doesn’t like to use buzzwords like “fundamental,” Shevlin nonetheless thinks the banking industry may be due for a shakeup or a fundamental rethinking of the traditional business model – especially when considered in light of competition from lighter, more agile neo-banks, like Moven or GoBank.
“The real challenge is what new products and services can they develop, dream up and implement that consumers would value and pay for,” Shevlin said.
“I don’t know if you’ve looked at your cell phone bill lately, but we pay for stuff that’s outrageous, and we don’t complain about that as much as if we get hit with a $5 monthly fee on our checking account,” he said. “The challenge won’t be solved within the next two or three quarters. It really takes a rethinking of the business model, how revenue is generated, and what consumers will pay.”
Laura Alix is a staff writer for The Warren Group.