Everyone knew it all along, and banks are now feeling the impact: All those loans made at super-low interest rates were profitable when interest rates on CDs and savings were low as well. But as rates have risen, profit margins have narrowed.
Last week, rates went up yet again, and while Fed Chairman Alan Greenspan is stepping down Jan. 31, President Bush’s choice to succeed him, Ben Bernanke, isn’t expected to make radical changes. A recent Bloomberg News survey of 88 economists predicted the benchmark lending rate would hit 4.5 percent and hold there through 2006.
So how is a bank to stay profitable in this changing climate?
The Washington Trust Company, based in Westerly, is betting on diversification. Even as it continues to grow its loan portfolio, the bank has invested in expanding its wealth management services, most recently with the acquisition of Boston-based Weston Financial Group.
The deal, completed Aug. 31, added more than $1.2 billion in wealth management assets under administration to the bank, for a total of $3.2 billion as of Sept. 30. And it helped boost wealth management and trust revenues to nearly $4.1 million, up 26 percent from last year.
“Wealth management adds more fee income to the bank, and provides a better balance with the interest income,” Chairman and CEO John C. Warren said in an interview. It “complements” the bank’s other services, he added, and provides a buffer in uncertain times.
“You can never tell what interest rates are going to do in any given day or any given month,” he said. “Alan Greenspan is going to retire; we have a new head of the Fed. What is that going to mean for the ability of banks to make loans?”
Consider this: In 1996, Washington Trust enjoyed a 4.60-percent net interest margin, but by last year, it was down to 2.74 percent. Since then, it’s rebounded slightly, to 2.78 percent in the third quarter of 2005, and interest income is up 11 percent from last year. But net gains on loan sales dropped sharply last year, almost 60 percent, and they’ve risen only slightly since then.
In addition, 2004 brought an explosion of free deposit accounts, which Washington Trust embraced as a way to gain market share, but which also cut sharply into account fees. Last year, deposit account fees dropped nearly 9 percent, and they’re down another 2.7 percent so far this year.
Gains in merchant processing service income have partly offset those declines, but what’s made a difference has been wealth management and trust services.
Financial management is not a new line of business for Washington Trust – it’s a longstanding part of its corporate identity. But its role in the company has grown, bolstered by the acquisition, in 2000, of the Phoenix Investment Management Co., which was Rhode Island’s largest independent investment management firm, with oversight of more than $1 billion in assets.
From 1998 to 2004, trust and wealth management’s contribution to operating revenues rose from 11 percent to 16 percent, and in the third quarter of 2005, it was 17 percent. Combined with other items, that line of business helped Washington Trust make non-interest income one-third of its 2004 revenues, up from just over one-quarter in 1996. With Weston in the mix, Warren said, it’s expected to rise to 38 to 39 percent.
Compare this to Bank Rhode Island, which last quarter derived a little more than 19 percent of its operating revenue from non-interest income. (Bank of America, in contrast, earned about $5 in non-interest income for every $6 in net interest income in the first nine months of 2005.)
Now, Weston – a “significant acquisition” for Washington Trust, as Warren described it, with a price tag of $20 million upfront, plus at least $6 million more over three years – is allowing the bank to diversify its revenue stream on yet another level.
Washington Trust’s existing financial services broke down into three categories: trust services, Phoenix, and 1800 Asset Management.
Phoenix, now renamed Washington Trust Investors, has a handpicked portfolio geared toward maximizing risk-adjusted return, and it caters to high-net-worth individuals and institutions, with a minimum $1-million investment.
On the other hand, 1800 Asset Management provides a more customized approach to investing – say, for the client who wants to keep his AT&T stock, but also put money into mutual funds.
Weston offers yet another approach, said Galan Daukas, the bank’s new executive vice president for wealth management. With clients that include executives at Fortune 500 and Fortune 100 corporations, Weston specializes in in-depth financial planning.
“They would call it personal strategic planning,” he said, “because the view is, first you have to establish the goals, what you want to accomplish – ‘I want to put my kids through college,’ or ‘I want to retire at 55’ – and then translate them into quantifiable financial targets.”
Many of Weston’s clients “may not have, today, a significant amount of investable assets,” Daukas said, because their money is often tied up in stock options and such. But they are prime clients for a bank to build a relationship with, and already, Washington Trust is being able to provide them with some additional services that Weston couldn’t offer.
“It does gain us much broader exposure, and exposure to a group of clients that we did not have significant exposure to,” Daukas said.
Conversely, Weston’s expertise and its approach to investments – it doesn’t buy stocks or bonds, but rather identifies top money managers to suit individual clients’ needs – expands the array of choices to Washington Trust customers and to new prospects.
“By being able to broaden our product array generally, and being able to tap the market with more arrows in our quiver and provide a comprehensive array of services, we’ll strengthen our overall growth potential,” Daukas said.
Asked how much further Washington Trust might expand in this area, Warren said the bank has no specific targets, but rather it seizes opportunities as they come up. Phoenix and Weston happened to be financial firms; First Financial, bought in 2001, was a retail bank.
Keeping a balance is important to Washington Trust, Warren said, and growing non-interest income is a good thing, “but we don’t have a target. What if I told you I’d like to get to 50 percent, and then tomorrow a great (retail) banking opportunity came up?”
“What we’re really looking to do,” he said, “is what’s best for our shareholders.”
