By Ray Birch
LAKE FOREST, Ill.—New data show banks continue to exit the overdraft market while credit unions step in to fill the void—giving CUs a revenue boost during the pandemic.
Economic research firm Moebs $ervices compared data prior to the Great Recession to the latest overdraft data to arrive at its findings.
Michael Moebs, CEO with the company, said NCUA’s first quarter Call Report data will ultimately show whether the strategy by credit unions to pick up more of the overdraft market is continuing, as CUs look to provide “much-needed” small-dollar loans to members “in this time of need.
“Credit unions are tapping into a big revenue source at a time when they are waiving fees and extending forbearance on loans,” said Moebs.
The biggest indicator of the shift in the overdraft market, according to Moebs, is can be seen in the size of the institutions making moves.
“At first, this was just happening among the too-big-to-fail banks, but now the community banks are also exiting overdrafts,” stated Moebs. “The door is wide open for credit unions to take over the OD business.”
The opportunity is big, said Moebs.
“Total overdraft lines systemwide are $60 billion, with only 60% of that being used,” said Moebs.
Basing its findings on a study of overdrafts at more than 3,000 depositories, Moebs $ervices’ data show from 2007, the year before the Great Recession, overdraft volume was down more than one-quarter at banks by the close of 2019, yet volume levels were up by a fifth at credit unions during this same period.
“Banks are signaling they want out,” said Moebs.
The Asset Difference in CUs
But it isn’t just at banks where asset size is a factor in what’s happening with overdraft offerings.
Michael Moebs
“Credit unions greater than $250 million in assets are moving to get more ODs,” explained Moebs. “The bigger CUs are moving to capture ODs. COVID-19 has turned the light on for depositories to tap the additional $24 billion available in overdrafts to help the consumer and small business. CU’s have a chance to do good.”
What has been turning banks away from overdrafts, contends Moebs, is a growing fear of unsecured credit.
“Overdraft behavior shows 50% or more of all checking users never overdraw, and 25% overdraw occasionally. Yet, 25% do it often,” explained Moebs. “Of the last group, about 40% have their account go negative and often is uncollectable. This produces overdraft loss on average of about 11%. Classic underwriting has a huge disdain for unsecured credit, such as overdrafts, credit cards and second lien loans like home equity. Classic underwriting has a fear of unsecured credit to the point this fear curbs credit to avoid offering overdrafts or avoid unsecured credit completely.”
A Clear Choice
Moebs, however, argues basic economics makes it clear that if the service is higher risk, FIs must charge a higher price to absorb more losses and maintain a profit.
“Fundamentally, the fear of unsecured credit goes away and becomes acceptable once earning at least 5% on assets with losses at 3%,” he said.
While credit unions are stepping up with overdrafts, Moebs believes a number of CUs, like banks, fear unsecured credit.
“Paratrooper recruits must conquer their fear of jumping from a plane—so, too, credit unions must conquer their fear of unsecured credit if they are to land the overdraft business from banks,” said Moebs. “The alternative is staying on the secured ground with low-value overdraft limits of $500 or less.”
Overdraft Pricing Strategies
Moebs suggested the following practices to effectively offer overdrafts:
- Measure volume and limits using FICO and other analytical tools—results are limits from $100 to $10,000+
- Give frequent users a freebie periodically—freebies are based on each consumer’s cost and depository revenue
- Refund infrequent users—value comes from charging then refunding, he said
- How many freebies? Moebs said CUs should base that on members’ individual standing with the credit union.