Regional and community banks are partnering with broker-dealers to bolster their in-house wealth management services and offset slowing revenue streams in other areas of the business.

That can mean competition for advisors as client aim to consolidate the number of financial institutions with which they work.

According to a report by Kehrer-Bielan Research and Consulting, a consulting firm focused on the bank and credit union channel, such institutions increased their investment services revenue by 17% in 2021.

“We are seeing a real convergence of banking and investing,” said Jill Zucker, senior partner for wealth and asset management at McKinsey. “Institutions that concern both sides of the balance sheet have become increasingly the preference for clients.”

Zucker said that the convergence has largely been driven by investor demand for a “one-stop shop” of banking, wealth management and financial planning support.

She cited a McKinsey poll of more than 10,000 affluent households that indicated the percentage of individuals saying they want to be advised by a single institution increased to 22% in 2021, from 13% in 2018.

Smaller retail banks must also compete with large, national outfits like Bank of America Merrill Lynch and Wells Fargo, that have large built-in brokerages and aggressively market wealth services to consumer bank customers. To address client demand, and competition, regional and local banks have been been driven to third-party brokers for technology and products.

“Roughly 50% of clients believe their primary wealth manager should improve their digital capability,” Zucker said. “And I think for some of the smaller banks, it's hard to match the investments of some of the larger institutions that have the scale to really invest in their digital platform.”

Ken Kehrer, partner at Kehrer-Bielan, said community and regional banks are turning to third-party brokers so that they can focus on reaching clients.

“Some banks have decided that what they’re really good at in the wealth management space is marketing, and [they’ll] rely on the broker-dealer to provide the advisors, manage them and provide the technology,” he said.

“A small bank would never have access to the technology that they could get by working with one of these large, large broker dealers. And advisors sitting in a branch in a rural area of the country could have the same tools that an LPL or Ameriprise advisor has,” he added.

Smaller banks have been driven to develop wealth management services as traditional streams of revenue dry up, he added.

“A lot of banks decided to drop overdraft fees, a significant source of revenue for banks, by far the largest component of their fee income,” he said. “One way to recover that loss is via the income from wealth management.”

What are brokers saying?

LPL has 35% of the total $2.3 trillion client assets processed by third-party brokers for regional and community financial institutions in the Kehrer-Bielan survey.

But some brokers’ market capitalization has been more specialized: Cetera is also strong among banks, while Cuna, which was acquired by LPL this year, tends to focus more on supporting credit unions.

Ken Hullings, LPL’s senior vice president of business development, said outsourcing to a third-party broker allows banks to focus on their traditional financial services and be a first point of contact.

“If it's not their core business, it's not going to get the investment that's needed to make it parity or parity plus, then you lose your main differentiator,” he said. When banks link with the broker-dealer, he says, they can focus on their core business—loans and deposits.

But transitioning to a broker can be a lengthy process for banks, particularly if they have spent resources to develop their own brokerage infrastructure.

“It's not an easy decision to make,” Matthew Audette, CFO of LPL, said at a Morgan Stanley conference in June. “They have internal departments and structures and investments that they've put in place, and they're walking away from a large part of that to come to us. So the dialogue is usually very deep, very long, very thoughtful.”

Wealth managers at regional and community banks are typically a direct employee of the bank, but registered with the outside broker. It's what Raymond James refers to as a "dual employee structure, said Tim Killgoar, senior vice president and head of the financial institutions division.

“We find that having the advisor truly as a team member within the bank or the credit union makes the internal partnerships just work more seamlessly. They're sitting on the same side of the table with the other bank employees, creating a holistic experience for the bank customers, as opposed to an external person coming in with a completely different business card.”

Jay McAnelly, group vice president at Ameriprise, said demand for outsourcing to third-party brokers has also been driven by wave of mergers among smaller banks.

“When you look at the regional and community bank population over the last 20 years, it's consolidated dramatically,” he said. “There was always a lower percentage of smaller community banks that offered wealth management. A lot of that might have been due to location or just due to the resources or the size of the institution. But today, now with that consolidation, these institutions are larger.”

Raymond James’ Killgoar agreed, saying outsourcing the brokerage arm allows small banks to remain competitive and keep their role within the communities they serve.

“Whether it's a defensive maneuver to remain independent, or a way to sort of continue to grow assets and get bigger and more robust, it's an important rationale to remain relevant in their marketplace,” he said.