Community Banks Raising Their Game After Reg E Setbacks

Still mourning the demise of overdraft fee income, smaller banks are nevertheless finding a variety of ways to compensate.

Among the tricks of the trade: innovation in non-lending activities; pushing clients into more-efficient services; and an increase in other fees.

"Community banks are asking 'What do we do to offset this loss of fee income?'" says Brad Smith, president and chief executive of Abound Resources, a community bank consulting firm in Austin, Texas. "Big banks have access to multiple fee-income streams. Community banks don't have a lot of those other fee-generating products, like insurance, or investment banking, or trust departments."

Community bankers have always had trouble increasing fee income, but their most recent troubles began in July 2010, when the enactment of an overdraft fee law put a major dent in their bottom lines. The overdraft fee regulations, commonly known as Reg E, required banks to obtain permission before enrolling customers in overdraft programs.

In annual reports filed recently with the Securities and Exchange Commission, several banks said Reg E contributed to declines in service charges on deposit accounts. Deposit service fees fell by $2.1 billion, or 5.9%, in 2011 compared to a year earlier, according to the Federal Deposit Insurance Corp. Noninterest income for all banks fell 7.4% in the fourth quarter from a year earlier, to $54.9 billion, according to the FDIC.

Although the law has crimped fee income, it has also jolted bankers to find new sources of it.

Henderson Citizens Bancshares in Henderson, Texas, has felt the sting; its noninterest income fell by about $1 million last year as a result of Reg E. So the $897 million-asset company developed fees and products to generate more customer relationships, particularly outside of lending.

Brad Tidwell, the president and chief executive of the company's Citizens National Bank, says some initiatives are in place; others are set to start in the next year. "We think we can make up most of that $1 million loss," he says.

Tidwell has added staff in the commercial department. The company has also hired four experts in Treasury services, with plans to hire another. They sell fee-based products such as cash management, Treasury management and payroll services.

"They're very knowledgeable about Treasury management and cash management, but they're not focused on the loan side," Tidwell says.

The bank's clients — businesses with annual revenue of $20 million or less — use fee-based services more than they borrow money. "Only about 40% of them borrow money, but 100% of them have checking accounts," Tidwell says.

Tidwell says Citizens National could also boost noninterest income by bringing the underwriting and risk-management responsibilities of its commercial credit-card business in-house. "We were not getting any revenue, but we were taking on all the risk," when the bank had outsourced those functions, he says.

Other banks, in trying to shift clients to more-efficient services, can benefit financially when the customer doesn't bite. The $4.3 billion-asset S&T Bancorp (STBA) in Indiana, Pa., for example, began assessing a fee on customers who chose to keep receiving paper statements. The fee generated $500,000 last year, recovering about 28% of the $1.8 million S&T estimates it lost in 2011 from the overdraft law.

Some banks, including $9.8 billion-asset F.N.B. Corp. (FNB) and $6.5 billion-asset Community Bank System (CBU), said higher revenue from debit-card fees helped make up for lost revenue.

F.N.B., in Hermitage, Pa., said the overdraft law reduced its deposit service charges by $1.7 million in 2011, though it was able to partially offset the loss with an increase in debit-card fees. Community Bank System, in DeWitt, N.Y., also used higher debit-card fees to offset lost revenue.

Some banks are finding silver linings in the regulatory changes. National Penn Bancshares (NPBC) in Boyertown, Pa., said its deposit service charges fell 11% last year, to $21.6 million. Still, the $8.5 billion-asset institution said in its annual report that the overdraft law also led to "improved customer saving levels" and "an increase in the average balance per account."

Berkshire Hills Bancorp (BHLB) in Pittsfield, Mass., said in its annual report that it "aggressively solicited" checking-account customers before the law was enacted, asking them to opt-in for overdraft privileges "to minimize the potential negative impact on overdraft volume and fee income." The move paid off for the $4 billion-asset company, as more than 80% of targeted customers opted for overdraft protection.