Fed Not Treating Overdraft Protection as Loans; Door Wide Open for Growth in CU Industry, but at What Cost?

WASHINGTON – Consumer groups don’t like it, but for now at least the Fed isn’t going to regulate overdraft protection as a lending product and vendors that sell the service say that’s good not only for their business and consumers, but credit unions too. If the Fed had moved to bring overdraft protection under Truth in Lending it would have called for an overdraft protection fee to be broken out into an Annual Percentage Rate. That would have all but killed the service for credit unions, according to John Floyd, president/CEO of John M. Floyd and Associates, one of the vendors marketing the service to credit unions. “It would basically tell the credit unions they are out of the business because they can’t charge more than 18% interest (usury laws),” said Floyd. If you broke down an overdraft fee into an APR it would likely be in triple digits. This would have devastated many CUs who depend on fee income in this day of tight margins, said Floyd. Not to mention overdraft protection, when done right, helps consumers, he said. “The popularity of the program proves it. At first everyone was saying, `gee our members won’t like this, this is not good.’ What they found is members love the program and it’s good for them. The best thing for the member is for the check to be paid, because if you return the check they really do get hammered,” said Floyd, who predicted that over the next two to three years almost all CUs will offer some sort of overdraft protection. Bill Strunk, president/CEO of Strunk and Associates, says regulators can’t afford to take away overdraft protection from financials. “We’re talking $100 billion they would be taking out of the banking system. They can’t do that. You’d be significantly hurting all the financial institutions in the United States. It constitutes about 50% of the total income for a lot of credit unions. There’d be no money left to build branches, build capital,” said Strunk. Jean Ann Fox, Director of Consumer Protection for the Consumer Federation of America, believes the Fed is giving financial institutions an unfair advantage that ultimately hurts consumers. “The bank is extending you money you have to pay back, and you pay a price for it. That’s a loan. We think consumers should know what that price is. Pawn shops, payday lenders and used car lots have to do it. Everyone has to tell the consumer what credit costs. The Fed is singling out banks (and credit unions) for preferential treatment,” said Fox. A representative from Financial Services Centers of America, Inc., an association which represents payday lenders, said it too is concerned about the uneven playing field and planned on submitting comments to that effect to the Fed to have the APR added. Fox said the CFA is in favor of overdraft protection, but why not tell consumers they have it and what it costs? “We think everybody should have overdraft protection. We’ve been arguing for years that financial institutions need to serve the small loan needs of their own account holders. With these courtesy programs you don’t even know you have it, you don’t sign up for it, you don’t know if you’re overdraft is going to be covered and you don’t know what it costs,” said Fox. “Instead of providing a better alternative with more consumer protection, financials that have adopted this have done the payday lenders one worse.” Joe Gillen, CEO of overdraft provider Pinnacle Financial Strategies, said assigning an APR would be difficult to do, and it doesn’t warrant an APR. “It’s not a loan product. It never has been a loan product. How do you calculate interest? When you’re doing a loan a consumer sits down and says `I want to borrow $300 over a period of time,’ ” said Gillen. With overdraft, financials don’t know if a consumer is going to make a deposit the next day, week or whatever to cover the check, so calculating an APR would be next to impossible, said Gillen. Fox said complying with TILA wouldn’t be as burdensome as the overdraft vendors make it out to be. “ It can be done through the open-ended consumer rules under TILA,” she said. Gillen said an open ended agreement would have to cover from the smallest to largest amount and shortest to longest timeframe, so it would vary wildly. The problem vendors and financials have with including an APR, Fox said, is consumers may not be as willing to use overdraft if they see a rate attached to it. Some consumers might see that it would be cheaper to take a cash advance (typically 50%) off their credit card than use overdraft protection. “One thing I’m hearing is that if financials had to comply with Truth in Lending, consumers wouldn’t use it as much,” said Fox. To that she basically said oh well. She said financials are making billions off the service and aren’t ready to put those dollars at risk. “There’s a huge bill being paid for the cash-strapped consumer here. If anyone deserves to know what credit is going to cost, it’s them.” Gillen said consumer groups some times don’t give consumers enough credit. “They act like consumers are uncapable of understanding. I think if you tell someone it costs $25 every time you do this, they’ll get it,” said Gillen. He also noted that overdraft is more about choice than anything else. “People have freedom to choose how they spend their money. Instead of paying a late mortgage payment, they pay a $25 overdraft and save themselves money. Consumers are pretty sophisticated in using the product to save money.” To make matters worse said Fox now consumers can overdraw their accounts using their debit card or at the ATM. “The ATM screen doesn’t pop up and say `you are about to overdraw your account, would you like to continue for so and so rate’. Consumers are in the dark,” she said. “When you think about folks who put their card in the ATM, this is not covering an overdraft, this is a real-time decision to lend you money. It doesn’t make sense that payday lenders have to give you the TILA disclosures and have a contract with you but banks don’t,” said Fox. Gillen said if the program was stopped for debit cardholders that would be a form of a discrimination because for many younger consumers, checks are obsolete, and using a debit card is nothing more than an electronic check to them. Gillen did concede that the problem at the point-of-sale or ATM is technology. “Not every financial has access to the latest and greatest technology from POS or ATM that tells them `by the way if you take this money you’re going to incur an NSF fee.’ Over the next three to five years, older technology will be replaced.” Fox said financials have exploited what was intended as an occasional exception in Reg Z to develop these systematic overdraft programs. Reg Z allows for the overdraft as long as the fee for the overdraft does not exceed the NSF and it exempts transactions where there is no written agreement between the consumer and the institution to pay an overdraft and impose a fee. One area the Feds’ proposal did weigh in on was advertising of the product. The Fed came down on vendors who market the program to financials. “What generally distinguishes the vendor programs from institutions’ in-house automated process is the addition of marketing plans that appear designed to promote the generation of fee income by stating a dollar amount that consumers would be allowed to overdraw and by encouraging consumers to overdraw their accounts and use the service as a line of credit,” the Fed stated in its proposed rule. The Fed proposal aims to eliminate misleading advertising by financials. Things such as misrepresenting the service as a line of credit and touts of the service being free will no longer be permitted. “There has been concern that some institutions promote bounced-check protection services as a feature of their free checking accounts, and that consumers may be misled into thinking that overdraft protection on such accounts is without costs,” wrote the Fed. Floyd conceded that he has seen some bad marketing out there, so the regs are justified. He said his company encourages credit unions to let members opt out of overdraft protection. “Our approach in our documents to the member is to be informative not marketing the product or being tricky with words. If they want to use it they can, if they want to opt out they can,” said Floyd. The Fed proposal encourages the use of opt-out clauses. The conventional wisdom the overdraft vendors preach is that if a CU bounces the check the member is not only hit by an NSF from the CU, but also a fee from their creditor (and in the case of most card companies, an increased interest rate), and to top it off a potential black mark on their credit report. “We went to Washington, met with all regulators and explained when you return a check insufficient, the credit union charges a fee, and the member has to pay Wal-Mart a late fee or a late fee on their mortgage. That’s what the regulators don’t get. They don’t look at it from that perspective,” said Strunk, who also noted that overdraft protection is only used by a small percentage of people. “About 15% of all checking accounts. For the other 85% this means nothing,” said Strunk. Fox said regulators seem to know overdraft protection is credit, but for some reason aren’t enforcing it. “If you read the FFIEC guidelines they talk about it as credit all the way through. You don’t talk about safety and soundness and risk if you’re not talking about it as credit,” she said. The FFIEC (Federal Financial Institutions Examination Council) put out guidance on overdraft protection, and Fox is right that it refers to credit risk throughout. The guidance seems to approach the subject as there are such a wide array of overdraft programs. It singles out the ones that are marketed heavily and encourage use of the product as potential credit risks. “The programs should be administered and adjusted, as needed, to ensure that credit risk remains in line with expectations,” said the guidance. Most CUs charge the same fee for an NSF as they do for overdraft protection, which typically ranges from $17 to $35. What about the good old days of banking when the institution would pull from a consumer’s savings account to cover a check and charge just a nominal fee? Fox described that is traditional overdraft protection. Floyd however said that doesn’t do much good for the people who really need overdraft. “Generally the people who don’t have any money in their checking account don’t have any money in their savings account,” said Floyd. His company does offer it however. What about the line of credit option? “That can be good for the member, but bad for the credit union. The cost of the processing and the increase in the overall loss ratio can exceed the income of line of credits,” said Floyd. And with line of credit comes TILA. Another problem CFA has with overdraft protection is most don’t specifically define which overdrafts will be paid and which ones won’t. Most credit unions that offer the service have a pre-determined limit (typically between $500 to $700, according to Floyd). Strunk said good programs use disclosures that clearly inform members the credit union may not pay their overdraft. “The credit union reserves the right to refuse it. If the account isn’t in good standing, they don’t have to continue to do it. That’s not encouraging members to write bad checks,” said Strunk. Strunk said credit unions just have to be sure they are running a good program. “It’s a political football, a regulatory football the consumer advocate people are after. They’re creating some storms. We’re just weathering the storm. If you do it the right way, there’s no problems.” Floyd said it’s interesting that this issue is coming up now as banks have been doing this for years. He said most banks used the “mystery” approach. They would use a matrix like approach (not systematic) to decide which checks to pay and which ones not to pay. Now with regulators looking for more specific disclosures, those systems may be on their way out. One more intriguing factor of the overdraft protection debate is Check 21. If and when Check 21 really does get image exchange moving, checks are going to clear a lot faster and thus financials stand to see even more overdrafts. Credit Union Times will cover this angle in an upcoming story. [email protected]