Profitability Issues: Fee or Free?

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The search for new noninterest income remains an incremental challenge

By Vanessa Drucker

It’s much cheaper for a community bank to prepare property valuations and commercial loan documentation in-house than to hire an attorney. So when regulations permit, employees at the Florida Bank of Commerce take on commercial property appraisals or tie up loose ends, like know-your-customer disclosures or tax form signatures. The $250 million-asset community bank in Orlando, Fla., always used to absorb the costs for these tasks for its commercial borrowers, although the tasks still cost valuable employee time and resources.

“The expense of processing is often missed,” explains Dana Kilborne, Florida Bank of Commerce’s president and CEO.

Now, for the first time, Florida Bank of Commerce customers are being billed for those loan-closing services, on a sliding scale by loan size and complexity, for preparation fees that were previously waived. The ability to pass along legitimate fees for services in today’s competitive marketplace, Kilborne says, is managing customer expectations and conveying value.

“Fortunately there’s been no pushback, since clients expect an appraisal anyhow, and we are saving them money,” she reports.

At a time when every dollar of revenue is helpful to maintaining profitability, Florida Bank of Commerce is not alone in looking for ways to pass along incremental operational costs. “Most banks now charge a processing fee for consumer loans, mortgages or commercial loans as a reflection of servicing efforts,” confirms Lynn David, president of Community Bank Consulting Services in St Louis. But David predicts, “as long as institutions provide quality services, customers will pay.”

A challenging environment

Industry studies have consistently confirmed for years that community banks charge fewer and lower fees than their competitors. Since the 2008 Wall Street financial crisis and recession, however, all community banks have had to labor harder to maintain overall profitability. Multiple headwinds of stiffer competition, lower loan demand and margins, and increased regulatory costs have challenged all community banks. In response, financial institutions, particularly community banks, have trimmed costs to the bone.

While net interest income streams have overwhelmingly driven profitability for community banks, the search for greater noninterest income to sustain profitability has been ongoing for years, even before regulatory rules placed new obstacles in providing profitable overdraft programs that many consumers want and need. More relationship–based community banks have been looking to find ways to charge for the actual services they render.

But don’t expect much sympathy from retail customers to the litany of challenges their banks are confronting, suggests Trent Fleming, a bank management consultant in Germantown, Tenn. “Most [financial consumers] don’t even want to pretend to understand how their bank has costs associated with its products,” he says. “Community banks have given away so much for so long they’ve spoiled customers.”

Fleming points to how for years many community banks have written off millions of dollars in non–sufficient fund fees for checks that could not be honored. After enjoying intense competition for their deposits, some consumers regard no–balance free checking accounts as almost a national birthright.

“If a service has traditionally been free a long time, people resent having to pay for it,” as Dan Geller of Market Rates Insight in San Anselmo, Calif., puts it.

“Most [financial consumers] don’t even want to understand how their bank has costs associated with its products. Community banks have given away so much for so long they’ve spoiled customers.”
—Trent Fleming, bank consultant

Meanwhile, consumers have become more sophisticated about shopping for loans and other financial services, and many are barraged with unsolicited offers from bank and nonbank financial service providers. Joseph Cady, managing partner at CS Consulting Group LLC in San Diego, estimates that 40 percent of customers would think about switching banks this year, and 20 percent may actually do so.

On the other hand, commercial customers are somewhat less hostile to new charges. The typical businessman understands profit margins and realizes that no concern can operate without observing them, Fleming notes. “They also know they are more demanding as customers and require extra work,” Geller says.

Commercial customers are realistic about paying for ACH origination, wire transfers, money handling of cash or coin, Internet banking access and remote deposit capture. In fact, remote deposit capture has been one product that consultants say banks could more easily charge a nominal fee to commercial customers. Some banks are looking at charges for frequently provided services such as handling returned mail when a commercial customer moves locations.

Making charges stick

Many community banks have been rethinking their fee structures and charges for the range of products and services they offer. There are strategies for making certain fees stick and sting less painfully, or for tying in conditions to continue free services that will make more customers more profitable, consultants say. The first place community banks should start in searching for new fee income is reviewing potential for charges that waived often for traditional products and services.

Some community bank executives might be surprised about the number of current fees that are being waived by staff, which can range from nonsufficient funds charges to late fees on loans, consultants say. Safe deposit boxes self-define their own value: When supply is oversubscribed, banks can consider raising the price across the board. Other formerly complimentary activities, like handling returned mail, should be compensated to reflect a bank’s time and effort. Likewise, bank employees who deal directly with customers may be reluctant to charge for time-consuming research.

To offset staff opportunity costs, Fleming advises institutions to double the salary cost of an employee’s time and add a markup.

But the best opportunity to introduce new fees is when a bank introduces a new product and service, bankers and consultants agree. Some relatively newfangled offerings where small fees might applied include smartphone apps for low-balance warnings or check deposit information; smart accounts that pay bills automatically by sweeping from high–yield money market accounts; and a service that credits deposits to accounts faster than the standard three– and four–day clearing period.

Credit-scoring reports represent another contemporary idea for an income source, Geller says. The service might be contracted with third parties and branded by a bank, he adds. “FICO scores today are not only important for loans, but to employers, who consider them for constructing a financial profile.”

Structures and bundles

Communicating value is everything when considering raising any fees or adding new ones, bankers and consultants agree. While overdraft fees have plunged by a third since 2010, for example, when opt-in overdraft regulations took effect, consumer demand for and appreciation of the value of overdraft protection programs has remained stable, consultants say. Customers understand that “their dirty laundry stays within the bank’s fiduciary responsibility, and they needn’t deal with merchants or collection agencies,” Fleming says.

“We do a poor job at employing the carrot versus the stick.”
—Joseph Cady, bank consultant

“We do a poor job at employing the carrot versus the stick,” says Cady, who mentions incentives like using mobile banking to motivate customers away from branches. Community banks should exhibit their value proposition in high-touch attention, as a fine restaurant or a resort would do, and bank employees on the front lines must also present fees for services as opportunities, and not apologetically.

Customers like choices, and are more likely satisfied if offered alternatives, David says. For instance, he suggests, “If you still want to be paper-based, add a fee for that option.”

But consumers are often confused and intimidated by a plethora of financial choices. So community banks can learn lessons about bundling products from the fast food industry. Decades ago pioneers in that industry discovered that consumers find it easier to choose a package than select individual items. Moreover, packaged orders are usually more profitable and take less time to administer in an a la cart fashion.

“Every community bank needs to research which items consumers want most, put them together in separate bundles and market them with names like ‘protection’ or ‘security,’” Geller advises. That pricing and delivery structure also sends a message: We’ve thought about your needs and tailored a package of the most important services to you.

“Don’t just hand them a sushi menu and let them pick!” says Fleming.

Of course, new fees may alienate some customers. For that reason, banks should continually benchmark their pricing and fees by observing their competition, but they shouldn’t automatically assume their competitors will know the correct fee schedule your bank should adopt either. Can a competitor be better than you at establishing your bank’s own costs of service?

David recommends interviewing customers who close accounts to learn what has prompted clients to depart. In a perfect world, community banks would closely evaluate customer sentiment when deciding to raise and lower fees, but realistically community banks rarely can engage in the detailed supply-versus-demand experiments. Common-sense judgment and firsthand experience at the front lines can work out just fine.

But done sensibly, charging a few pennies here or there for a highly valued product or service, particularly as lending margins remain tight, can make a big difference in the bottom lines of any community bank.


Vanessa Drucker is a financial freelance writer in New York.