For years overdraft fees helped fuel Woodforest Financial Group Inc.'s fat returns and fast growth.

Even through the financial crisis, when most banks lost money, the $3.3 billion-asset Woodforest consistently posted a stunning return on equity in the 30 percent range and continued adding scores of branches every year.

But regulatory changes could undermine its strategy. As the industry contends with new rules that bar banks from covering overdrafts on debit cards without customers' permission, Woodforest offers an extreme example of the potential impact. Last year more than half of its revenue—interest and noninterest income combined at its bank and thrift units—came from fees on transaction accounts, according to data from Foresight Analytics. The average was 5.9 percent for all holding companies with assets of $1 billion to $5 billion.

Robert E. Marling Jr., Woodforest's chairman and chief executive, says his company intends to slow its growth as it assesses the shifting regulatory landscape. He expects its net income will shrink by up to 15 percent once the overdraft changes take effect this summer."I think most banks are expecting a decline in the revenue," Marling says. "It is just a fact of life that revenue is going to be diminished and companies are going to have to be creative."

But unlike most banks, Woodforest is so dependent on fees that it has attracted regulatory scrutiny lately. An April consent order fined its thrift unit $400,000 for unfair and deceptive practices, forced it to repay $12 million of overdraft fees to customers, and demanded it devise a new business model that relies less on fees.

Marling says the company expects regulators to sign off any day now on a plan that calls for the thrift to start originating mortgages. He could not say whether the bank unit also faces regulatory action.

The accusation of unfair and deceptive practices arose from its "Absolutely Free Checking," which charged overdraft fees. The account has since been renamed.

"Obviously misleading any customer is damaging to a franchise," Marling says. "It is extremely important that the industry be clear and as transparent as possible."

Woodforest, which is based in The Woodlands, Tex., operates more than 660 branches in 17 states, predominately inside Wal-Mart stores. Its returns have long outpaced industry averages and have risen even more significantly since 2005, when it began opening the Wal-Mart branches outside of Texas at a rapid clip.

Though the in-store locations have low deposit balances, do not make loans and, in some cases, stay open around the clock, the expansion proved lucrative, partly because of the account fees Woodforest collected. Overall Woodforest's branches average only $4.3 million of deposits, even counting its 40 traditional ones in Texas.

Industry observers say in-store branches are cheaper to build and operate than a traditional branch, which might need to amass $25 million to $30 million in deposits to break even. A typical in-store branch has less than $10 million in deposits. Still, they agree that it'll be a struggle for Woodforest to maintain its outsized returns, at least in the near term.

"This is clearly a fee-based model," says Ken Thomas, a bank consultant and economist in Miami. "It's a model built on a large number of low-deposit branches charging deposit fees repeatedly to the same customers."

Often in-store branches attract customers who, being inexperienced with banking, incur more fees. So these branches are "particularly vulnerable to fee erosion" with the new overdraft rules, says Steven Reider, the president of Bancography, a bank consulting firm in Birmingham, Ala.

But Reider doesn't believe the industry will see fee income drop by 50 percent at in-store branches, as some predict. "I certainly think it has some diminishment of the attractiveness of the in-store proposition. But I don't see this change being as acute as others do."

Consultants and bankers say that many customers are opting in for overdraft protection and that more are likely to do so once their debit cards get declined because of insufficient funds. In Woodforest's case, 85 percent of new customers since April have signed up for the service, Marling says.

The privately held Woodforest also has changes afoot to cut expenses and generate additional revenue, but Marling would not give specifics. "We are adjusting like most institutions, looking at our staffing models and in some cases our hours of operation," he says. Already the company—which sometimes added as many as 150 branches a year—is slowing the pace of its expansion as a result of the weak economy and uncertainty over what the government's massive regulatory overhaul will bring. It opened 100 branches last year and expects to open about 50 this year.

Marling says the company, which charges $34 for each overdraft incident, offers financial education programs to help its customers. It also removes the first fee that customers incur for insufficient funds if they take an online financial literacy course.

Dave Martin, an executive vice president at the consulting firm NCBS, says Woodforest's customers are more likely than most to opt in for overdraft protection, though they might wait until after their debit cards get declined. "There is a tendency to say this bank makes a ton of money on fees, but at the end of the day the product they are providing is what customers want."

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