Make Bank Fees Work for You

Every winter when I receive my first heating bill, my jaw drops open at the amount I owe. Then I make plans--only half-joking--to buy natural-gas futures or invest directly in energy stocks to hedge against a similar series of super-sized bills sure to come the following December.

Even though I never follow through on those tactics, at least I can console myself with the fact that heating is a necessity if you live in Chicago and hope to avoid a nasty case of frostbite. But what about high-priced expenses that can be avoided, such as bank-deposit fees? After all, most people seem to have a story about how they got nickeled-and-dimed by their bank one time or another. Are these fees really becoming that big of a deal, and if so, can investors profit from them?

In a nutshell, I think so. And in fact, for savvy consumers and investors, I'd go so far as to say that there are fast becoming two kinds of banks in the world: 1) the type you'd want to invest in and 2) the kind you'd want to do business with if you're a penny-pincher.

Fee Frenzy
Consumers aren't just imagining that deposit fees have shot upward at a gangbuster rate. Among publicly traded banks and thrifts--which house the vast majority of deposits in the industry--deposit fees have grown at a phenomenal 17% compound annual rate from 1990 through 2003, the last year for which comprehensive data is available. That's pretty heady growth for an industry often mischaracterized as having stodgy expansion prospects. To put these fees in perspective, every man, woman, and child in the United States spent about $11 per year on average in 1990 on deposit fees with the nation's publicly traded banks and thrifts. By 2003, the sum had risen to $73 per person, or about $194 per household!

What's the big deal about these fees? For starters, they're basically pure profit for most banks. In conversations with banking executives, I've heard some describe how a low-balance "free checking" account is barely profitable until the customer finally overdrafts his or her account by a couple of bucks, and then cha-ching, the bank collects $30 or more. If overdraft protection fees were translated to an annual percentage rate for the short period of time that most consumers lack sufficient funds, the interest rate on the loan would easily top 1,000% or more, according to Consumer Reports.

The Effect of Fees on Demand
Not only have these fees taken an ever-increasing bite out of consumers' wallets--to the benefit of banks and their investors--but consumers don't seem to care. Or if they do, they don't do much about it. A McKinsey & Co. report published in 2002 found that 38% of banking customers can't even remember the last time their bank raised prices on their checking accounts, and only 2% of all consumers actually moved their accounts as a result of the higher fees. In fact, among many large banks, the annual rate of customer run-off is generally about 15%, roughly equal to the number of people who move from one home to another every year--and likely take their bank accounts with them. Inertia is a very powerful force that banks benefit from year in and year out.

Our own study of bank deposit fee data seems to support the McKinsey findings. Using data from SNL Financial, we compared the average deposit fee that 459 publicly traded banks charged customers. There's a wide array of subcomponents to the line banks report as "deposit fees," such as check-writing fees and other surcharges--and these subcomponents can vary from bank to bank--but the overwhelming bulk of fees industrywide are earned from good old-fashioned bounced checks. Thus, rather than split hairs, we looked at overall fees as a percentage of the bank's total deposits.

We then ran a regression of annual deposit growth versus deposit fees as a percentage of deposits over one-, three-, and five-year periods. We found a slight negative correlation, suggesting that higher fees reduce demand--but not by much. For a supposedly commodity industry, banks have unusually great pricing power.

Your Bank vs. Your Bank Investment
Thus, from an investor's perspective, these fees combine three great attributes: fat profits, fast-growing revenues, and consumers indifferent to price. Needless to say, fees have helped make some banks attractively profitable businesses to invest in. As evidence, we ranked all publicly traded banks by total return, which includes capital gains and deposits. Banks that generated total returns to shareholders that were above the group median over the past five years generally charged about 10% higher prices for deposit fees than the below-average banking investments.

Looked at another way, banks with above-average deposit fees generated total returns of 14.6% per year on average over the past five years versus a 10.1% return for banks with below-median deposit fees. An equal-weighted bank portfolio would obviously fall halfway between these two return figures, or about 12.4% per year, and the KBW Bank Index--which is weighted heavily toward larger-cap issues--delivered an 8.4% return per year over this period.

All of this isn't to say that banks can't deliver stellar returns without jacking up deposit fees, as evidenced by  Bank of Hawaii (BOH),  First Bancorp (FBP), and  North Fork , all three of which delivered top-tier returns to shareholders and below-average fees to their customers. (See charts below.) Still, banks like these have been the exception, not the rule. And I don't know about you, but I'd rather invest in the type of company that delivers outsized returns to its shareholders, but park my deposits at a bank that doesn't realize the fee bonanza they're missing out on. Who knows, by doing so, maybe I'll even make enough in the market--or save enough on fees--to cover a heating bill or two next winter.

Banks to Bank On  Best-performing banks for shareholders among the nation's top 50 depositaries
	Deposit Fees (as a % of Deposits)	Total 5-Year Return to Shareholders ( % )
First Bancorp (FBP)	0.21	29.1
Commerce Bancorp	0.98	25.4
TD Banknorth	0.57	22.4
Bank of Hawaii (BOH)	0.49	20.3
Hibernia	1.02	19.3
Compass Bancshares	1.32	18.1
TCF Financial*	2.60	17.0
North Fork Bancorporation	0.50	16.0
BOK Financial (BOKF)	0.88	14.2
M&T Bank (MTB)	0.84	14.0
Group Average	0.94	19.6
Source: SNL Financial * Deposit data is five-year average through 2003. 2004 data is not yet available.

Banks to Bank With  Lowest-priced banks for customers among nation's top 50 depositaries
	Deposit Fees (as a % of Deposits)	Total 5-Year Return to Shareholders ( % )
First Bancorp (FBP)	0.21	29.1
Valley National Bancorp (VLY)	0.30	1.4
Mercantile Bankshares	0.40	7.1
Associated Banc-Corp (ASBC)	0.47	11.8
Marshall & Illsley	0.47	-0.7
Bank of Hawaii (BOH)	0.49	20.3
PNC Financial Services (PNC)	0.49	-7.2
Sky Financial Group	0.49	8.4
North Fork Bancorporation	0.50	16.0
Colonial BancGroup	0.52	12.7
Group Average	0.43	9.9
Source: SNL Financial