Bill Cooper is no stranger to a fight. The chairman and chief executive of TCF Financial Corp. used to walk a beat as a Detroit cop, and later did a stint as head of Minnesota's Republican Party, sparring regularly with Democrats and whoever else came into his sights.
This time around, things are more personal. The fate of TCF, the Wayzata, Minn.-based company he nurtured from its deathbed in the 1980s into one of the most profitable banking enterprises in the country, might depend on it.
Last October, Cooper, 67, went where no other banker has dared venture, suing the Federal Reserve to block restrictions on debit-card fees mandated by the Dodd-Frank Act. In late January, he added Comptroller of the Currency John Walsh as a defendant.
The lawsuit has put Cooper at the front of a supercharged battle to beat back a Fed proposal to cap debit-card interchange fees at 12 cents per transaction for issuing banks with more than $10 billion in assets. That's a far cry from the 44 cents banks get from the typical debit-card transaction now, and, bankers say, below the true cost of providing the service.
While other bankers lobby Congress, complain to the media and investors, or plot strategies for surviving in a world where debit interchange revenue is a fraction of current levels, Cooper has opted to challenge the constitutionality of the proposal in court. "There's a lot of law that says regulatory agencies can't set a price that's lower than the cost to provide a service," says Cooper, who filed suit in U.S. District Court in South Dakota, where $18 billion-asset TCF moved its charter in 2009. "It's like Congress telling Burger King that they can't sell the hamburger for any more than the cost of the bun."
The suit, considered a long shot by many legal experts, has earned Cooper the respect of many peers, but-thus far, at least-little tangible support. As of February, no other bank or industry trade group had stepped up to join TCF as a plaintiff or even offer an amicus brief in its support.
"You have to admire his moxie," says a regulatory attorney for one of the megabanks, which has not joined the suit but is quietly cheering Cooper on. "It takes a lot of guts to sue your regulatory agency."
Cooper likens the lack of support to confronting a bully in a bar. "The guy wants to step outside, and all your friends say, 'Here, let me hold your coat while you go out and fight him.'"
But he's not afraid to go it alone. He almost seems to relish the spotlight.
"Bill is a street fighter," says Richard Epstein, a University of Chicago law professor who is part of the company's legal team in the suit. "He was a cop who worked his way through night school. He's not some Ivy League pussy."
Cooper isn't just tough. He also has more to lose. TCF has been one of the industry's top performers over the past decade, turning in 63 straight quarters of profit, including the most recent one. Until recently, it was regularly generating annual returns on equity in the 25 percent range and returns on assets above 2 percent-both nearly double the average for midsize Midwest banks, according to SNL Financial.
"They've been more consistently profitable -and more profitable in absolute terms-than any of their peers," says Tony Davis, an analyst with Stifel Nicolaus & Co.
The performance leans heavily on fees from retail accounts. While the average midsize Midwest bank gets about 9.5 percent of its total revenue from account-related fees, according to a Stifel analysis, the total for TCF is a whopping 31 percent.
The financial crisis was fueled by irresponsible lending practices that TCF never bought into. Indeed, its credit quality has held up well, due largely to smart underwriting and a lack of unsecured lending. Classified loans were 2.7 percent of the total loan portfolio at yearend, about the same as a year earlier.
But Washington's primary triage has been to attack fees-first through Reg E, which required banks to acquire customer opt-ins for overdraft protection, and now the crackdown on debit-card interchange-a twin blow that strikes right at the heart of TCF's business model. "I mean, what the hell did I do?" Cooper asks incredulously. "I never made a foreign loan or had an off-balance sheet anything. I never securitized an asset. I never used Fannie [Mae] or Freddie [Mac] or bought their preferred stock. I never made a subprime loan. I don't lend money outside of my marketplace. I never did a credit swap or owned a derivative. And yet now they come down and torture me? Why?"
TCF was a pioneer in the free-checking movement, marketing accounts to the lower-middle-income masses with a convenience-based formula heavy on supermarket branches and long hours. Today, it has nearly 1.5 million retail checking accounts, 60 percent with customers who have annual incomes of $50,000 or less -a cost-conscious group Cooper refers to collectively as "Joe Lunchbucket."
Those customers don't pay anything for their accounts upfront, but TCF gets about $330 in revenue from each account annually from service and automated teller machine fees and debit-card interchange charges, according to court documents.
Tackling the opt-in provision for overdraft coverage required intensive effort at TCF over the course of last year, but needed to be done. The company raked in $273 million in insufficient funds fees and service charges in 2010, or about 22 percent of its total revenue.
TCF took some bruises along the way. To make up for the anticipated loss of fee revenue, the company announced in January 2010 that it would begin imposing a $9.95 monthly service charge on accounts that didn't maintain a balance of at least $500 or use direct deposit. By May, it lost about 250,000 accounts.
"It was precipitous-a huge, huge drop," says Anne Layne-Farrar, a director with consultant LECG, who studied TCF's business model for an affidavit filed with the lawsuit. "In four months, they lost everything they had gained since the beginning of 2004."
TCF saw fourth-quarter service-charge revenue drop 18 percent versus a year earlier. But it has persevered with customer outreach efforts and loosened eligibility for free checking, by eliminating the minimum balance requirement for accounts that have at least 10 transactions a month. "We found we have a lot of accounts that go below $500, but are very profitable because they're very active," Cooper explains.
Today, nearly 90 percent of new TCF customers agree to pay fees if their accounts are overdrawn. The overall opt-in rate is 65 percent.
That's better than some other large banks have reported; a few, including Bank of America, decided simply to stop offering overdraft protection on debit cards.
Still, Cooper is smarting over having to put in such effort. "It was hugely expensive and time-consuming, and accomplished nothing in terms of improving things for customers, but we did it," he says.
The government blow to interchange fees, however, can't be overcome with mere elbow grease. The Durbin amendment, a hurried addition to the Dodd-Frank Act, directed the Fed to "establish standards to ensure that an interchange fee is reasonable and proportional to the issuer's costs." The amendment also dictated what costs the Fed could consider-failing to include equipment, distribution, fraud coverage and other overhead.
This virtually assured the fee would be unreasonably low, bankers argue.
Even so, the industry was shocked at just how low. The Fed surveyed big banks on the variable costs of the processing and came up with the 12-cent proposal in December.
Early drafts of the amendment targeted banks with more than $1 billion assets, but couldn't garner enough votes. The size cutoff kept rising, finally finding support at $10 billion. According to SNL Financial, just 95 banks had assets above that level at the end of June 2010. "The [cutoff] number was totally arbitrary," says Epstein.
Institutions with less than $10 billion in assets remain free, at least for now, to continue charging prevailing rates, creating the potential for unequal competition.
Anyway it's sliced, Durbin is especially bad news for TCF. The 60th-largest bank in the country by asset size, TCF ranks as the No. 11 issuer of Visa debit cards, processing more than 200 million swipes each month. The company fetches an average of 47 cents per transaction, or 1.35 percent of the typical $35 debit-card purchase it processes, according to court documents. In 2010, that amounted to $111 million, or 9 percent of its total revenue.
"Durbin would have an inordinately large impact on TCF, because it has a relatively large concentration of debit cards, and relies on those fees to help drive its business model," says Scott Siefers, an analyst with Sandler O'Neill & Partners.
Cooper's alternatives aren't good: He could accept lower returns, which would likely hammer the stock price and make it difficult to raise capital or even sell for a decent price. Or he could add another service fee-the company estimates it would need to charge the average checking account about $8.33 monthly to make up for the lost revenue-and suffer the consequences.
LECG's Layne-Farrar predicts TCF would lose another 250,000 accounts if it added that fee. Because of the exemption for banks with less than $10 billion of assets, "TCF customers will be able to look a block away and see another bank that offers nearly identical services without a fee," she says.
Both are bad options, so Cooper sued instead, in hopes the court will halt implementation of the Fed's recommendation before its target date of July 21.
Mounting a legal challenge isn't without risk. "For investors, it's as simple as, 'If this is an issue that's worthy of a lawsuit, then I need to be concerned about TCF,'" says Siefers, who has slashed his earnings estimates for the company by more than 20 percent, for fear that TCF could lose as much as $80 million a year in interchange revenue. "In a sense, they've put a target on their own backs. But what choice do they have?"
Epstein says debit-card interchange operates on a "two-sided market," where things work well enough for retailers that it's worth sharing some of the wealth with the facilitators of that tool, the banks. The interchange platforms, including Visa and MasterCard, play the role of middleman, managing the massive volume of transactions and setting a price.
Epstein says a fair price works in everyone's best interests. "As long as the total cost is less than the benefits to both sides, it makes sense for the guy with the big gain position to equalize the transaction and keep the other guy in the game," she says.
The Fed's recommendations amount to a "confiscatory taking" under 19th century law governing regulation of monopolies and oligopolistic networks, Epstein argues. "The government cannot push prices so low that you can't recover your costs over the life of the project," he says. "It's a bait and switch. TCF made these investments in good faith, thinking it could get a competitive rate of return, and now it's being chopped" by about 75 percent.
A hearing on the matter is scheduled for April.
TCF's battle over the Durbin amendment is the latest chapter in a long-standing tussle between banks and retailers over $16 billion-plus in annual debit-card interchange fees. In 2005 alone, for instance, retailers filed 41 separate class-action suits against banks, arguing that the fees were set illegally.
The amendment, slipped into Dodd-Frank at the eleventh hour by Sen. Dick Durbin, D-Ill., was lawmaking at its ugliest-rushed, uninformed and favoring one special interest (in this case, retailers) at the expense of another, bankers say.
"There were no hearings. No one had the opportunity to hear both sides of the story," says Viveca Ware, senior vice president for regulatory policy with the Independent Community Bankers of America. "In the interests of getting a bill approved, the House acquiesced."
While the provision was positioned as protecting smaller merchants and consumers, Durbin admitted on the Senate floor that it was a response to complaints by Gregory Wasson, CEO of Deerfield, Ill.-based Walgreens, the nation's largest drug-store chain, that interchange fees were his fourth-largest expense.
Merchants have an argument: The fees garnered from debit-card interchange are enough to subsidize free-checking accounts and rewards programs at banks around the country. Why should they foot the bill? The Fed proposal brings U.S. interchange fees more closely in line with those in Europe and other parts of the world, proponents say.
Consumer rights groups also have thrown their support-and moral authority-behind Durbin. In congressional testimony last year, Pedro Morillas, a consumer advocate with the California Public Interest Research Group, bemoaned the "reverse Robin Hood effect" of interchange fees, which he argued redistributes wealth from all consumers-in the form of higher retail prices-to those who use cards. The "oligopolistic concentration" of issuers allows them to "engage in a variety of unfair and anti-consumer practices," he concluded.
Cooper says that the consumer groups are being duped, and that there's no way retailers will actually lower their prices. "They misunderstand how the process works," he says. And besides that, consumers will have to start paying for checking accounts. "It's let's make people pay for something that they currently get for free to benefit some of the largest corporations in America."
Cooper isn't alone in his opposition, and other bankers are beginning to make noise. During the January conference call season, big-bank CEOs launched what looked like a coordinated attack on Durbin. The 12-cent cap is "an absurd intervention in the free-market system," griped BB&T CEO Kelly King. "I'm not in favor of government price controls," added Wells Fargo CEO John Stumpf. "What product is next? What industry comes next?"
JPMorgan Chase's Jamie Dimon lauded the advantages of the debit card, saying it costs as much as 70 basis points for retailers to process, handle, move and insure cash and checks. An underlying notion behind the amendment was "that retailers pay zero for cash and zero for checks," he told analysts. "That was a false premise."
Dimon also worried aloud about the "adverse consequences of making a portion of current banking clients unbankable." With a drastic cut in interchange fees, JPMorgan "will not be able to profitably serve" about 5 percent of its existing customers, he said.
Most big banks are throwing their weight behind a fierce lobbying effort aimed at derailing-or at least softening-the Durbin amendment.
Community banks, which at first glance would appear to benefit from being able to continue charging higher fees, don't like the amendment, either. While the transaction processors have said they will support a dual interchange schedule that would allow smaller banks to remain at their existing revenue levels, the ICBA's Ware says that once the precedent is set, it's only a matter of time before interchange reductions spread to banks with less than $10 billion of assets and credit unions as well. "We strongly believe that small financial institutions will not benefit from the exemption, due to marketplace dynamics," Ware says, adding that it might be easier to get the amendment repealed than modified.
The industry has some important allies, including Rep. Barney Frank, D-Mass., whose name appears on the financial reform law. Rep. Spencer Bachus, R-Ala., chairman of the House Financial Services Committee, has filed a comment letter with the Fed requesting a slowdown on its rule-making process so Congress can take a second look. His committee was scheduled to hold hearings on the matter in mid-February.
But next to the economy and budget woes, revisiting the Durbin amendment remains a relatively low priority in Washington, and the Senate seems less sympathetic to the banking industry's arguments. "At this point, I am hunkered down and ready for the fight that's coming," Sen. Durbin said during a December floor speech. "The biggest banks and credit card companies are going to do their best to influence the Federal Reserve to raise the interchange fee as high as possible, but we know [they] have been overcharging for years."
Add it up, and it's quite possible that Cooper's suit might be the industry's best hope of winning this fight.