Regional banks' fee income jumps 12%, narrowing gap with Wall Street megabanks

Regional banks are closing the gap with Wall Street megabanks as fee-based revenue surges on AI-driven corporate demand.

Regional banks in the KBW index posted a 12% sequential jump in noninterest income in the second quarter, nearly matching the 13% rise at megabanks, as lenders pivoted toward fee-based services tied to the AI boom.

"Our pipeline of M&A deals is at a record level," said Christopher Gorman, chief executive officer of KeyCorp, which has been expanding its middle-market investment banking services.

Noninterest revenue at regional banks reached about 50% of net interest income in the second quarter, up from roughly 40% in early 2023, according to Visible Alpha figures. Huntington Bancshares Chief Financial Officer Zachary Wasserman told analysts last week the bank expects to land "at the higher end or above" on fees even if net interest income comes in at the lower end of its outlook.

The shift matters because regional banks trade at a fraction of the valuation of their Wall Street peers — below 1.5 times book value for Truist, KeyCorp, Huntington, M&T Bank and Zions Bancorp, compared with more than 2.5 times for JPMorgan Chase and roughly 3 times for Goldman Sachs and Morgan Stanley. If the AI boom drives middle-market companies to seek more capital-raising and advisory services, those discounts could narrow.

From Consumer Lending to Commercial Relationships

Truist Chief Financial Officer Michael Maguire told analysts the bank is "reallocating capital from higher-yielding consumer loans into higher-quality but lower-yielding commercial loans, where we expect to drive attractive relationship returns over time." The strategy involves bundling lending with fee-generating services such as capital raising, merger advisory, payments and wealth management — a model that allows banks to boost returns on equity even as net interest margins compress.

Truist's investment-banking and trading income surged 72% from a year earlier, helping lift its return on tangible common equity to 15.4% from 12.3% even as its net interest margin narrowed 0.04 percentage point. The dynamic illustrates how regional banks can offset margin pressure through fee-based revenue — a shift that has accelerated since early 2023, when noninterest income represented just 40% of net interest income at these lenders.

The recent jump in Treasury yields — with the 2-year note hitting its highest level in more than a year — has intensified pressure on bank deposit costs. Regional lenders without large Wall Street trading desks face particular risk as clients move cash into higher-yielding alternatives. Yet the same rate volatility that squeezes net interest income also drives fee revenue from capital markets activity, creating a natural hedge for banks that have built out those capabilities.

Cheaper Bet on the AI Boom

Last week, shares of Bank of America, Citigroup and JPMorgan Chase gained while most large regional banks in the KBW index declined, reflecting investor skepticism about Main Street lenders' ability to compete with their larger peers. But the gap may be narrowing. KeyCorp's Gorman said a "bifurcation" exists between megabanks and middle-market-focused banks because bigger clients tend to move first, but Key's record M&A pipeline suggests smaller companies are catching up.

The Wall Street megabanks have been building out their own ability to serve smaller customers, increasing competition. But it also confirms that these clients have business worth chasing. For investors willing to bet that middle-market companies — often in less-glitzy industries such as construction — will also benefit from the AI boom and need investment-banking services, regional banks offer a cheaper entry point at less than 1.5 times book value.

Not all regionals are succeeding equally. NBT Bancorp, a New York-based community lender, missed second-quarter revenue estimates this month, with net interest income of $137 million falling 1% below consensus. The mixed results show that banks with established investment banking operations are benefiting most, while traditional lenders face continued margin pressure.

The last time regional banks saw such a rapid fee-income expansion was in 2021, when SPAC-driven M&A and low rates fueled a surge in advisory revenue. That boom faded as the Federal Reserve raised rates. This cycle differs because AI-related corporate demand is driving structural rather than cyclical growth, according to bank executives.

This article is for informational purposes only and does not constitute investment advice.