As community banks adjust to big rule changes on overdraft fees, a new threat looms in the courtroom.
Recent lawsuits could stop community banks in at least two states from deliberately processing the largest transactions first — a method that triggers additional overdrafts and thus higher fees — after a California judge ruled against Wells Fargo & Co. last month.
The Wells decision may prompt regulators to prohibit the practice altogether, KBW Inc.'s Keefe, Bruyette & Woods Inc. warned in a study released Tuesday.
The case "could raise the whole issue of high-to-low service charges and its benefit or negative impact on consumers," said Jefferson Harralson, a KBW analyst and one of the study's authors. It's unclear who "will pick up the torch and continue to carry it, but the practice is laid out for review."
It's tough to predict how wide-reaching the effect of such a ban would be, Harralson said. In 2008 the Federal Deposit Insurance Corp. found that nearly 25% of banks surveyed process debit and check transactions from largest to smallest; of the surveyed banks with assets topping $1 billion, more than 53% used the practice.
Community banking companies that process transactions highest-to-lowest include the $3.6 billion-asset Renasant Corp. in Tupelo, Miss.; the $10.5 billion-asset Citizens Republic Corp. in Flint, Mich.; the $13.7 billion-asset Susquehanna Bancshares Inc. in Lititz, Pa.; the $6 billion-asset First Commonwealth Financial Corp. in Indiana, Pa.; and the $8.5 billion-asset Hancock Holding Co. in Gulfport, Miss.
Many banks that KBW surveyed would not disclose information about their processing practices. Several declined to comment when reached by a reporter, or did not return calls seeking comment.
It's also difficult to predict how a ban on the practice would affect community bank revenue, though the study said the Wells case is a good indicator.
In his decision in August, U.S. District Judge William Alsup ordered Wells to repay $203 million in fees — about 15% of the service fee income generated since it began processing transactions from high-to-low. The company is appealing the decision.
The study said other banks could face a similar hit, although Harralson noted that smaller banks may be somewhat less exposed, because they tend to focus more on commercial business while overdraft fee income tends to come from retail customers.
Nessa Feddis, a vice president and senior counsel at the American Bankers Association, said she expects regulators will eventually consider changes to rules affecting the order of processing. But she noted that the issue has been the subject of debate and litigation for decades, and said a Federal Reserve study found that customers want important payments — such as rent, mortgage or other bills — processed first, and they're willing to pay for it.
"I think it will be addressed, but it's a complicated issue," she said. "Consumer preferences vary, individual consumer preferences can vary based on the transaction or the day. So that's the tricky part."
Yet Harralson said the judge's decision in the Wells case was unusually critical of the practice, and unusually descriptive of the way the process works, providing a road map for future legal or regulatory action.
Since that ruling, a Minnesota woman filed a lawsuit against TCF Financial Corp. in Wayzata, Minn., for posting biggest-dollar transactions first, hoping to turn the case into a class action lawsuit. And a similar suit — also seeking class action status — was filed against the $16.6 billion-asset Bank of Oklahoma in Tulsa. Neither company returned calls seeking comment on the lawsuits.