By most measures, community banking companies had a good first quarter that included improved net interest margins and solid gains in loans and deposits.
But the earnings would have been even better for many if not for a decline in service charges on deposit accounts.
Income from such fees, which helped drive banking profits in recent periods, dropped sharply in the first quarter because of two factors: rising interest rates and a decline in bounced checks.
Cullen/Frost Bankers Inc. in San Antonio said income from service charges on deposit accounts shrank by roughly 11%, or $2.3 million, from a year earlier. The $9.8 billion-asset company attributed the decline mostly to the fact that it collected fewer fees from commercial customers. As interest rates rose, those customers earned more credit on deposit balances and thus paid fewer fees on transactions, Cullen/Frost said.
State Bancorp in New Hyde Park, N.Y., also reported an 11% drop in service fees, though its decline was mostly on the consumer side.
Doug Vergith, a vice president at the $1.5 billion-asset company, said it typically assesses a $25 overdraft fee, but customers are getting more educated about such charges and, as a result, are overdrawing their accounts less frequently.
Many other community bankers are detecting similar trends.
Though large banking companies are generally reporting an increase in service charges, a review of earnings reports filed to date shows that income from such charges is down significantly at banking companies with less than $10 billion of assets.
According to Highline Data Banking Services' analysis of reports filed with the Securities and Exchange Commission, income from the fees has dropped nearly 19% at banking companies with less than $300 million of assets; 13.5% at those with $300 million to $1 billion; and 29% at those with $1 billion to $10 billion.
Mark Muth, an analyst with First Horizon National Corp.'s FTN Midwest Research Securities Corp. in Nashville, said industry observers expect the decline in service-charge income to continue as interest rates rise and consumers become more savvy about paying a fee of $20 to $30 on an overdraft.
Not that bankers and analysts are particularly worried. Though income from service charges helped prop up earnings when loan demand was weak, it generally accounts for just a small fraction of net income. With commercial loan demand picking up, the charges are expected to play an even smaller role in the overall profit picture.
Still, most analysts and bankers interviewed for this story said they were caught off guard by the decline in service-charge income, particularly on the consumer-deposit side.
In recent years bankers have reported record increases in overdraft fees as they added sophisticated overdraft-protection programs. But such programs came under fire from consumer groups, which said the programs encouraged people to overdraw their accounts. Regulators responded by issuing guidelines asking banks to provide more disclosure on their overdraft policies.
Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets, said that because banks now provide more disclosure, consumers are not as tempted to be overdrawn.
John A. Scaldara Jr., the president and chief operating officer of the $1.2 billion-asset Columbia Bancorp. in Maryland, offered another explanation for the decline in consumer fees.
Account holders are circumventing automated teller machine fees by getting cash at the point of sale, or by paying bills and transferring money online - things that sometimes involve a fee if done through a teller, Mr. Scaldara said.
"Consumers are more aware of the benefits of the debit card and how to use them to avoid ATM-transaction fees," he said.
Some bankers said service fees fell in either commercial or consumer accounts in the first quarter, but others noted declines in both.
At Columbia, service fees on deposit accounts fell by about 25% from a year earlier, to $750,000, Mr. Scaldara said. "We are getting hit from two sides … in our commercial business and on the retail side."
One larger banking company, Huntington Bancshares Inc. of Columbus, Ohio, reported a 6% drop in service-charge income, to $37.6 million.
Huntington attributed the drop to lower commercial fees as a result of increased credits for commercial customers and a "decline in consumer service charges, primarily reflected in lower personal NSF and overdraft service charges."
In general, though, service charges on deposit accounts are rising at large banks. While large banks also reported declines in fees from commercial accounts, they said that fee income from consumer accounts more than made up for it.
According to Highline Banking's data, banking companies with more than $10 billion of assets reported an average 19% rise in service-charge income.
Analysts said they were not surprised by the drop in commercial fees, because interest rates have risen steadily in the past year. Because banks cannot pay interest on business-checking accounts, most try to keep large customers happy by waiving fees (typically 20 cents for a commercial transaction) to a certain limit, which is called a compensating balance or credit.
The limit, determined by a percentage of the customer's balance, is based on the three-month Treasury bill rate, which has risen to 2.7%, from about 1%, in the past year.
With a limit of 1%, a commercial customer maintaining a $10,000 balance would receive a credit for $100 of fees a month before it must start paying them; at 2.7%, it does not begin paying transaction fees until they hit the $270 mark.
Mr. Cassidy at Royal Bank of Canada said that, with interest rates so low in the past few years, transaction fees kicked in quickly and resulted in record charges from commercial customers.
But the higher interest rates rise, the lower fees will go, he said. "Banks have been getting a free ride from corporate customers for so long, and now that's starting to change."
Mr. Vergith at State Bancorp said the drop in income from service charges is not necessarily a bad thing. He pointed out that overdrafts come with their own headaches and often create more back-office work.
Also, he said, fewer overdraft charges "means customers are keeping higher balances - and you can't be disappointed when there are more deposits."
