Exclusive: Fees, not loans, help banks recover

While the struggling U.S. banking industry has shown signs of life, recent SEC filings reveal that banks are relying heavily on fees and other non-interest income -- not loans and interest -- to make their comeback. Some say this trend is bad for consumers, and shows banks are still unnecessarily fragile, but the banking industry said it's just good business sense to diversify their revenue streams during tough times.

An analysis of the banks' quarterly filings with the Security and Exchange Commission since 2006 by the investment research firm EDGAR Online also shows a clear correlation between non-interest income and employee compensation. In other words, the higher a bank's fees, the more money its workers make.

Of the nation's top 500 banks, 384 have increased so-called non-interest income – dramatically in many cases. Considered on a per-employee basis, Wells Fargo has increased its non-interest income by 80 percent since the first quarter of 2007, for example, while Bank of America and Fifth Third Bank have seen non-interest income rise by 28 percent and 26 percent, respectively.

Only 80 of the top 500 banks showed a drop in fee-based income, while fewer than half of all banks reported an increase in interest earnings over the same period.

And some banks with high non-interest income increases have seen drops in interest income. BB&T Bank saw a 33 percent increase in fee-based revenue at the same time its lending-based revenue declined 6percent. Bank of America's interest income dropped 12 percent during the same stretch.

Among the largest 85 U.S. banks, 55 have higher non-interest revenue since the beginning of 2007, while only 23 have increased interest income, the analysis shows. And at 65 of the 85 banks, non-interest income grew quicker than interest income on a per-employee basis.

Non-interest income is a catch-all accounting phrase for many sources of bank revenue, and should not be strictly equated with familiar consumer fees like overdraft or credit card fees. The category also includes investment banking services, mortgage origination, insurance sales, brokerage services and many other bank products.

Philip Moyer, CEO of EDGAR Online, said he's concerned that banks' reliance on fee-based income is a sign that they've gotten away from their core business of lending. And it indicates to him that banks are more concerned with earning fees than making loans

"They make fee after fee after fee, but if they are just collecting fees this is not a very healthy system," he said.

Loans spur additional economic activity, he noted, in some cases helping start small businesses or allowing families to move into new homes. Fees don't have the same multiplier effect.

Diversified revenue 'positive'

But Greg McBride, an analyst with Bankrate.com, said that banks are wise to diversify their revenue streams. He said healthy increases in non-interest income could be interpreted as a sign of strength for a bank.

"That trend is nothing new," he said. "The financial services industry has made a concerted effort to place emphasis on fee-based services. Why? Interest income is cyclical. Interest rates go up and down. How do you stabilize that? You add in some lines of business that offer more predictable revenue… (Lending) is a competitive business with low margins and banks have to look to other areas to fill their revenue gaps."

And Jim Cheesen, chief economist at the American Bankers Association, said the results are not surprising, given the weakness in demand for loans during the recession. He said strong non-interest income should be interpreted as a sign of strength.

"There's a whole host of other lines of business that banks have -- and those are doing better in this environment than the lending side is," he said. "... It shows that those institutions were diversified to begin with and have a balanced source of income and that's a very positive thing. I find it remarkable to jump to the conclusion that there have been efforts to drive more income through the non-interest channel. Those channels were already there."

He also said that when the economy recovers and loan demand increases, a similar study would show that interest income would climb faster than non-interest income.

Studies such as EDGAR Online's have been made easier by new rules requiring banks and other public companies to file electronic versions of SEC quarterly reports that make data mining easier.

EDGAR Online examined characteristics like FDIC premiums paid, gain or loss on asset sales and total deposits. Theonly close correlation found, according to Moyer, connected non-interest income and employee compensation.

The role of compensation in the recession

"We were trying to figure out how compensation may have figured into the financial crisis," Moyer said. The relationship between fee-based services and compensation suggests to him that banks have misaligned incentives. "It doesn't matter if banks are writing bad loans, buying and selling bad assets, or if deposits are going down or customers are angry ... compensation is based on fees," he said.

McBride, however, said he wasn't surprised by the connection, which he said has a logical explanation.

"When you run a business, you pay your salespeople based on commission, on the revenue they generate" he said.

The data provided by EDGAR Online generated additional curiosities.

Large banks were much more likely than small banks to show non-interest income increases. Capital One, Bank of America and Wells Fargo all were among the top 10 in fees per employee in the most recently reported quarter. But none of those banks cracked the top 10 list for interest income per employee, which was dominated by relatively small banks, such as Astoria Financial, New York Community Bank and Hudson City Bancorp. For example, Astoria Financial was able to generate twice as much interest income per employee as Bank of America during the quarter.

Again, McBride wasn't surprised: Most smaller banks have not made the same effort to add business segments like financial management or investment banking, he said. And a few large clients could skew such averages, McBride noted.

Cheesen offered another explanation: He said that smaller banks typically enjoy wider margins on loans than larger banks; often, they are competing for different kinds of loans.

The list of banks that increased non-interest income the most since 2007 proves less conclusive, with both large and small banks registering sharp gains. For example, First Horizon's non-interest income per employee jumped 137 percent; Fulton Financial jumped 49 percent; Fifth Third Bancorp jumped 26 percent.

It's been well documented that fees contribute mightily to most banks' bottom lines. This is obvious from the data: On a per-employee basis, most large banks – including Wells Fargo, Capital One, Fifth Third and SunTrust -- earn about 50 cents from fee-based services for every dollar received from interest income.

Moyer said he raised concerns about fee-based income because he's worried that banks are still overly focused on short-term gains. Many fees -- such as mortgage origination fees -- generate immediate revenues but do not foster good long-term investment practices, such as sound mortgage lending, he said.

"It simply tells me nothing has really changed in terms of the pervasiveness of generating fees inside of banks," he said. "For a lot of that activity, no one knows if it's good or bad activity."

Loans vs. fees: Where your bank stands

The chart below shows that, in many cases, salaries and non-interest income at the nation's top 85 banks rose between the first quarter of 2007 and the second quarter of 2009, even as lending-related interest income declined.

SOURCE: EDGAR Online, SEC filings.