By Ray Birch
LAKE FOREST, Ill.—Get ready for life without overdrafts—and for the potential loss of more than $6 billion in revenue annually to credit unions.
That’s what several analysts say lies ahead as a result of the CFPB’s new rules on prepaid as the agency looks to do away with the service across all payment channels, not just prepaid. Sources told CUToday.info that financial institutions that rely on overdrafts and the resulting revenue stream need to begin formulating replacement revenue strategies now.
Those strategies will likely involve increasing and adding fees, something CUs dodged under the Durbin rule carve-out, and this time analysts predict it won’t just be the big banks wearing the black hats in consumers’ eyes.
The CFPB’s proposal classifies prepaid overdrafts as a loan. Experts say this will put a stop to the limited practice of tying the cards to overdrafts, since the move opens the prepaid card up to all of the Reg Z requirements. If the CFPB applies the same classification to checking overdrafts, the additional costs—and hassle—that come from a raft of new compliance issues, along with what one expert believes will be a dramatic reduction in what FIs can charge per overdraft, will prompt many FIs to stop providing the service and get back to bouncing checks and adding NSF charges.
Fees, Loan Rates Rise
Not only will banks and credit unions be forced to increase fees in several areas, they may raise loan rates as well.
“The CFPB’s intent with the proposal is to change the face of overdrafts from ‘credit but not a loan’ to a loan fully subject to Truth-In-Lending,” said Michael Moebs, economist and CEO at Moebs $ervices.
Moebs contends that if the CFPB wants to address overdrafts it should not “sneak rules in the back door” and instead should propose a separate regulation. “Ultimately, this changes government policy on overdrafts. Every bank, credit union and thrift needs to establish a strategic policy for the potential elimination of overdrafts.”
Moebs says the CFPB’s intent is to eventually reach to all payment channels on classifying overdrafts as a loan. “I estimate this will cost the credit union movement $6 billion annually and affect approximately 30% of the membership who will be without a much-needed service.”
Odysseas Papadimitriou, CEO of WalletHub and CardHub, Washington, agrees that the CFPB intends to unify all payment channel overdrafts under the same guidelines. “The CFPB has finally found a way to kill most of these overdraft fees,” he said, adding that most financial institutions offering overdrafts will likely stop providing the service add fees, and come out looking bad in front of consumers. “Any financial institution that relies heavily on overdraft fees is now like a cocaine addict whose cocaine is about to run out.”
$32 Billion At Stake
In play is approximately $32 billion in overdraft revenue, coming from 40 million Americans who use overdrafts, according to the recent Moebs $ervices Study on Overdraft Revenue. Overall about three-quarters of FI fee revenue, 77%, would be lost if overdrafts are eliminated, the study shows. Credit unions would be impacted most because their ratio of overdraft revenue to total service charge revenue is 93%—almost 30% higher than banks, noted Moebs.
Dennis Dollar, principal at Dollar Associates, Birmingham, Ala., is another who sees the CFPB’s position on prepaid as a strong indicator of where the agency is headed on checking accounts. “And it should give both banks and credit unions great pause,” said the former NCUA chairman in a previous report. “If the CFPB brings overdraft programs under Reg E and Reg Z, it would bring about the end of overdraft programs as we know them.”
Bob Giltner, CEO at R.C. Giltner Services Inc. in Louisville, Ky., thinks there should be little speculation among banks and credit unions as to where the CFPB is headed regarding overdrafts.
“The CFPB is in charge and these new rules (regarding checking overdrafts) should be proposed in the fall of 2015 to go into effect in 2016,” said Giltner, who believes the Fed won’t totally do away with overdrafts (see related story). “I certainly agree CUs should begin now planning for this, and at l
east a 20% drop in NSF revenue in 2016.”
Moebs said conversations his firm has had with hundreds of bank and credit union executives while assembling the company’s overdraft study indicates most financial institutions will drop overdrafts if the CFPB makes it difficult and too costly to provide the service.
The key to most decisions, pointed out Moebs, is that overdrafts, subject to Truth-In-Lending rules, would be limited to a maximum interest of 36% APR annually. He said an average $100 overdraft would have a maximum of $3 of revenue if outstanding for a month. Moebs added that most overdraft balances are outstanding for less 10 days so in most cases credit unions will learn less than $1.
“With the cost of overdrafts—direct functional costs and indirect functional costs—at $12.50 for most institutions and the interest only at $3 a month, the CFPB is signaling to lenders, including payday lenders, that the cost of an overdraft or advance will exceed the allowable revenue,” said Moebs.
Consumers Will Pay
What will happen when FIs stop offering overdrafts, said Papadimitriou, is more consumers will pay the costs for running the financial institution. “With overdrafts in place, you have a small percentage of consumers who subsidize everyone else. If those fees go away, the other consumers will have to pay their fair share.”
Financial institutions will have to focus on greater efficiency, said Papadimitriou, and that means more online offerings.
“Online accounts don’t rely on overdraft revenue, instead they rely on a very low cost structure to service these accounts,” said Papadimitriou.
Papadimitriou emphasized that big banks have a huge edge on credit unions with physical locations, but suggested credit unions can “turn the tables” by extending their reach online. He fears, however, that CUs won’t embrace the opportunity at a time when their consumer appeal is high.
“We talk to a lot of credit unions and I am disappointed in their thinking,” said Papadimitriou. “Credit unions offer superior service than banks, but they are not embracing this online opportunity. It is mind boggling to me how they are resisting technology that can be a big help to them.”
Analysts see advantages in digital checking offerings like Walmart’s GoBank account, and suggest CUs consider similar products. “Overdrafts today are less than one-third of transaction liquidity fees, but CUs are so focused on overdraft they are foregoing other segments and delivery methods,” said Giltner.
Moebs believes credit unions will have to go beyond adding fees and raise auto loan, mortgage and HELOC rates. NSF fees will have to go up sharply, as well, from a median price of $28.50 to $40 to $50, he proposed.
“Credit unions must also reduce their expense on the transaction side,” continued Moebs, who reminded that the real losers are consumers. “The CFPB, by targeting overdrafts, will put about 40 million Americans in a quandary over where do they turn for help with their financial positions. They need another source to help them when their money runs short, and under these new rules, they don’t have one.”
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