Overdrafts' Demise May Be Overblown

Don't underestimate the staying power of overdraft protection.

Less than two months before new rules on the coverage take effect, early indications suggest banks won't suffer as big a blow to fee revenue as feared.

Ever since the Federal Reserve announced last year that it would require financial institutions to get consumers' consent before enrolling them for overdraft protection on debit card purchases and automated teller machine withdrawals, it was widely assumed that customers would opt out in droves.

New research, as well as anecdotal evidence, indicates otherwise. That means features like free checking — which some have put on the endangered species list — might not be headed for extinction after all, at least not just yet.

A recent study from ACTON Market Intelligence shows that consumers who use overdraft protection on a regular basis are likely to opt in and are willing to pay for the coverage — in some cases, even more than they pay now.

"Losing overdraft fees is not a foregone conclusion," said Gary Gabelhouse, an analyst at the unit of ACTON Marketing LLC. "The bank doesn't have to lose. An enlightened bank can make this work."

After surveying nearly 1,300 consumers around the country in February and March, ACTON determined that 58% of all customers would opt out. However, the vast majority of those who use overdraft protection regularly will choose to keep the service. As a result, the study, which ACTON distributed to its clients last month, concluded that about 73% of the nation's overdraft business is secure, leaving only 27% of the business at risk.

Under the Fed's Regulation E, banks and credit unions have until July 1 to obtain permission from new customers and members, and until Aug. 15 to get permission from existing customers.

Of the 100.1 million debit card accounts in the country, 37% had been overdrawn and used their respective bank's overdraft protection at least once in the past year, according to the ACTON study.

Thirty-five percent of overdraft users are considered "heavy" users, meaning they use overdraft protection more than 10 times in a year. That slice of the market accounts for 81% of all overdrafts every year, ACTON said.

The study found that heavy users "would likely pay even increased fees — even $45 per covered transaction."

Still, several banks have recently moved to reduce some of their fees and cap the number of times a person can be charged in a single day for overdrawing his or her account. Analysts called such moves a way to boost banks' overall image, which can be more valuable than the fees themselves.

"When you get into overdraft, you also have the moral high ground that some banks are trying to play," said Hank Israel, director of checking and payments for Novantas LLC, a New York consulting firm.

Robert Sterner, executive vice president at Velocity Solutions Inc., a financial services consulting firm in Wilmington, N.C., said most of his clients have forecast a 10% to 15% decline in overdraft-related income.

All the evidence suggests that an overwhelming majority of customers are opting in for the service, he said.

"They are telling us at a very high rate that they want to have the same service that they have been provided historically, and that flies in the face of what consumer groups have said," Sterner said. However, he acknowledged the early numbers could be skewed a bit since one could draw the conclusion that most people who respond right away are probably heavy users of the service.

First Tennessee Bank, a unit of First Horizon National Corp. of Memphis, started alerting customers to the changes only last week, but Dave Miller, its head of retail banking, is encouraged by what he's seen so far.

"Our view is that a significant number will choose to opt in," Miller said. Research shows 70% of First Tennessee customers, when alerted at an ATM that they are about to overdraw on their account, withdraw the money anyway, he said. There are about 2 million overdraft transactions in a given year at First Tennessee, Miller said.

Regions Financial Corp. also doesn't expect a big impact on business from the rule change, but in its case, it's because a very small portion of its customers use overdraft regularly, said Evelyn Mitchell, a spokeswoman for the Birmingham, Ala., bank.

During the second half of 2009, less than 7% of Regions customers were charged overdraft or insufficient-funds fees more than four times in the six-month period, she said.

Still, Regions has changed its fee structure to simplify things for customers. In April, the bank eliminated the fee on overdrafts of $5 or less in a day. It also capped the number of fees it would charge for multiple overdrafts or transactions with insufficient funds in a given day at four, down from eight. A handful of other banks, including First Tennessee and Wells Fargo & Co., have also put limits on the number of overdraft fees they assess in a given day and have eliminated fees when an account is overdrawn by $5 or less — in effect quieting some of the criticism over banks charging $35 for the proverbial $5 cup of coffee.

Regions also moved from a tiered structure that was based on the number of overdraft or insufficient-funds occurrences to a flat fee of $35. Wells charges a flat $35 fee on overdrafts of more than $5, as well. The San Francisco bank has said that it expects about $500 million in lost fees this year from the rule changes.

U.S. Bancorp, which has also made changes to its fee structure, has forecast a pretax impact of between $300 million and $400 million as a result of last year's credit card reform act and the crackdown on overdraft fees.

In addition to capping accounts to three overdraft fees in a single day, waiving fees on overdrafts of less than $10, U.S. Bancorp said last week that it will reduce overdraft fees to $10 for transactions of $20 or less.

This year, Bank of America Corp. went a step further than many of its competitors and eliminated overdraft fees on debit purchases altogether. Starting this summer, the Charlotte bank will block debit card purchases that would overdraw accounts. So consumers who don't have sufficient funds will be denied the purchase at the point of sale.

Some analysts suspect that even if the impact on fees from the overdraft regulation is minimal, the industry is still headed toward a more fee-based model in general. "There is a pressure to find new fee income," said Gwenn Bezard, research director at the consulting firm Aite Group. "The trend away from free checking is still real. … The problem is [demand for] lending is not great."Fiaz Sindhu, an executive in Accenture's banking practice, agreed that banks are going to need to re-evaluate their checking products.

"The current model is unsustainable, and I think the banks know it's unsustainable," he said. "I think that as they run their analysis in the next few months, you'll probably see some more definitive direction about what they are going to do."

Sterner, however, warned that coming up with new fees isn't necessarily the best way to make up for lost revenue. The idea should be "to get those low-usage accounts to begin interacting with the bank," he said. "Apathy is the biggest concern."