Regulation E Predictions: It Will Hurt, But Not Be a Death Blow
One thing certain about the Regulation E overdraft requirements passed last November is that they go into effect for new accounts July 1 and existing accounts Aug. 15. What is uncertain is the impact the new regulations will have on credit union income.
Callahan & Associates and the Filene Research Institute both attempted to shine some light on the possible impact the regulations will have on credit unions' bottom line.
Callahan Industry Analyst Lydia Cole estimated the potential changes in credit union noninterest income from Reg E. In 2009, Cole said that credit union noninterest income totaled $11.6 billion and that NSF and courtesy pay fees accounted for 28.1% of total noninterest income, which equals approximately $3.26 billion in income for the credit union industry. Since Reg E does not require consumer opt-in for check and recurring ACH payments, Cole estimated fee income from those sources will remain the same, but an estimated $1.82 billion from debit, point-of-sale and ATM overdraft fees is up in the air. The impact a credit union will see in fee income relates to how many members choose to opt-in, but Cole estimates the potential effect on credit union ROA will likely be around 10 basis points.
Last week, the Filene Research Institute released a report, "Overdraft Regulation: A Silver Lining to the Clouds?" The report was created from a 185-respondent credit union survey Filene conducted over the past few months. Half the credit union respondents to the survey were federally chartered and almost all were federally insured, two-thirds had at least $100 million in total assets and the median membership of respondents was 36,650.
Worst-case scenario, if no members opt-in for overdraft services, the report said that total fee income would sink by as much as 11% and that overall ROA could fall by as much as nine basis points. At the same time the report said that while the worst-case scenario would result in a tangible drag on earnings, it would not destroy the credit union business model.
"It will be a knock, but not a significant bleed," said Mark Meyer, CEO of Filene.
The survey found that the median percentage of respondents' fee income from overdraft was 39.5%. Eighty percent of respondents have automated overdraft programs, as opposed to linked-account programs or line of credit programs. Of those that offer automated programs, 18.3% do not inform their members and 14.8% require members to opt-in to the program.
The Filene report also offers a look at how credit unions can get around Reg E to maintain fee income. The current ruling does not put restrictions on the order in which items are processed. Since Reg E does not apply to checks and ACH transactions, if a credit union posts point-of-sale and ATM transactions first, it would be the check and ACH items that cause the overdraft and would still be subject to a fee even if a members chooses not to opt-in.
The survey suggests that the best route for credit unions may be to maintain consumer-friendly features and survive with diminished ROA.
Other data from Callahan suggests that some credit unions are already moving in this direction and are relying on other sources than overdraft fees for noninterest income. Callahan's year-end 2009 noninterest income survey showed that in December 2009 respondents reported overdraft fee income made up 27.4% of total noninterest income, while in December 2008 the group reported it made up 29.6%. However, analysts said that the decrease is not likely in dollar amount but from the growth of noninterest income coming from other sources.
The largest source of noninterest income for credit unions is now interchange income from debit and credit cards.
In a traditional economy, Meyer said that it may be plausible for credit unions to simply continue to survive on reduced noninterest income, but the indsutry's fear is that while the decrease in income from overdrafts may not be a fatal cut in itself, it may be one of many cuts the industry will see this year.
"I'm not surprised that the fee income model we relied on for a decade is under attack. It means that we need to start paying attention to innovation and thinking about new business models. There are ways to have consumer-friendly fee income business models. It's just not easy. It takes a lot of hard work," Meyer added.
State Employees Credit Union in Raleigh, N.C. falls into the category of credit unions that offer a line of credit program as opposed to a courtesy pay overdraft program. The line of credit already requires members to opt-in, but the credit union has created two new member-friendly services that address overdrafts.
The first, launched this month, is an electronic account called "Cash Points Global." The account has no overdraft protection, so if there is no money in the account the transaction is denied. The member has the option to transfer money online between accounts to cover transactions. The account is promoted as a controlled spending account for students.
In May the credit union will roll out a text alert service to provide members with alerts about balances and transactions. In July, the credit union will launch a service called "Another Chance." In order to use the service, members have to sign up for overdraft protection. If the overdraft protection has run out, an alert comes through to the member via text or e-mail, and the member has until the end of the day to make a deposit to cover the transaction or the transaction gets returned.
"We don't have the view that fee income from overdrafts is something we should look to build," said CEO Jim Blaine. "Members will make the correct choice if you inform them. That's what credit unions ought to do."
Marc Paine, executive vice president for overdraft program provider Strunk & Associates, said that the company is instructing its clients to focus on making sure they are doing the best job to get information out to members.
"If they have a fully disclosed program they should concentrate on that program. If it was working before, it should continue to work going forward," Paine said.