Overdraft Fees Draw Critical Scrutiny in New Filene Report

Some credit unions are dissatisfied with their overdraft policies, and are considering ways to make them fairer and more useful to members, according to a study released Thursday.

The Filene Research Institute of Madison, Wis., conducted in-depth financial analysis and interviews with 16 credit unions for its 35-page report, “Overdraft Protection Programs: Credit Union Best Practices” written by its economist, Luis Dopico.

Many of the credit unions felt their programs were either simple but ineffective (“one size fits none”) or too complicated for members to understand. Analyzed from a different view, many credit unions are reassessing their programs to get a more nuanced understanding of their members’ needs and motivations.

The credit unions’ responses were anonymous, but the sentiments have been shared by the many banks and credit unions that have announced they were eliminating or cutting their overdraft fees.

This week Bank of America joined Capital One and Wells Fargo in eliminating punitive overdraft fees.

Among credit unions, Alliant Credit Union of Chicago ($14.7 billion in assets, 631,700 members) eliminated overdraft fees entirely last summer and many others have announced plans to eliminate or significantly curtail them.

Overdraft protection programs are relatively recent among banks and credit unions. They quickly gained popularity after 2000 as a way to help members avoid a string of non-sufficient fund (NSF) charges from both their bank and the merchant.

For example, one 18-year-old bank customer in the late 1970s had consistent low balances in his checking account and inconsistent exercise of subtraction. He tended to have many small-purchases in the $2-$4 range at fast food restaurants, such as Sam & Andy’s on The Strip by the University of Tennessee in Knoxville, which served an irresistibly mouth-watering steamed roast beef sandwich with smoked cheddar.

The local bank, whose motto was “We Start with You,” started with him on at least a couple occasions. He discovered that when one check bounced, it incurred a fee on the order of $25 from the bank and from the restaurant. And right behind it bounced checks two, three and four.

The bank need not have feared reputational damage. The FDIC raided the bank in the early 1980s and its president pleaded guilty to bank fraud.

This hapless fellow would have been considered a “light overdrafter,” who overdraw only once or twice a year and accounts for about 16% of members. The biggest group is “non-overdrafters,” who account for 82% of members.

The “heavy overdrafters,” who account for less than 2% of members, include “crisis overdrafters,” who experience a large number of overdrafts following a job loss, medical emergency or other crisis. Then there are “habitual overdrafters” who overdraw their accounts on an ongoing basis, month to month, for extended periods of time.

“Many habitual overdrafters may decide to overdraw their accounts intentionally, using the service as a tool for personal financial management or income smoothing,” the study said.

The study challenged credit unions that approach overdrafts as virtue demerits, or see the practice as evidence of ignorance, requiring a heavy dose of financial education.

It also acknowledged that overdraft fees have become important sources of non-interest income for some credit unions. As net income margins have been generally declining as a percent of average assets since 1980, non-interest income has been rising.

Among the sample credit unions, non-interest income was 1.44% of assets and overdraft protection income was 0.17% of assets. The reliance varied widely. Overdraft revenues “are close to rounding errors in the financials of some credit unions but account for large fractions of revenues for others,” the study said.

Many of the credit unions in the study were concerned that overdraft revenues were being extracted disproportionately from the 2% who are heavy overdrafters. They worried that overdraft protection revenues bore little relation to the risks or costs of overdrafters. Among the respondents, overdraft protection charge-offs were 0.014% of assets or 8% of overdraft protection revenue.

And, they worried that ultimately overdraft protection fees “result in members with lower incomes and weaker credit histories cross-subsidizing the services provided to members with higher incomes and stronger credit histories,” the study said.

The study said one unnamed credit union is introducing a new premium checking account with a monthly maintenance fee under $5. Members using this premium offering would be exempt from courtesy payment fees and would bear very low insufficient funds fees ($7).

“The credit union intends to promote this offering not only to heavy overdrafters but also to non-overdrafters and light overdrafters, promoting the product as providing peace of mind,” it said.

Some credit unions are considering deposit accounts that are automatically linked to home equity lines of credit with the goal of minimizing overdraft protection and insufficient funds fees.

Credit unions might also be reading their members and their numbers wrong. While overdraft protection programs are technically not loans, they might not be recognizing the extent members are demonstrating credit worthiness by repaying their courtesy payment (CP) balances reliably.

Based on low charge-off rates, the study said credit unions might consider:

• Increasing courtesy pay limits to members who reliably repay their CP advances.
• Reducing courtesy pay fees to members who reliably repay their CP advances.
• Transitioning members who reliably repay their CP advances to standard loan products that are, in terms of rates, less expensive to members, such as small- dollar loans, credit cards, and particularly, lines of credit.
• Experimenting with larger lines of credit for most members, particularly those who directly deposit their incomes.

“Credit unions can serve members with weaker credit by offering them, among many other services, small- dollar loans, personal loans, workout loans, debt consolidation loans, secured credit cards and credit cards with limits that start low but can increase as members’ credit histories improve,” the study said.