WEST PALM BEACH, Fla. – Are credit unions unknowingly keeping check cashers and payday lenders in business? Well, they're at least helping by returning all of their members' bad checks, instead of paying them like many banks do, say some leading consultants specializing in overdrafts. "We've gone from 200 payday lenders in 1990 to 11,000 today and it's just growing. Go into any town you want and there are payday lenders, and there are also credit unions in those towns," said William Strunk, chairman of Strunk & Associates, L.P., a Houston-based consulting firm that is advocating that credit unions get out of the NSF business and into the overdraft privilege business. While over 37% of credit unions that offer share drafts do not allow overdrafts, only about 3% of banks do not allow them. According to numerous national studies, approximately 89% of Americans do not reconcile their check books. Of the 11% that do, about half of them only do it once a year. The result? Many good-intending consumers are bouncing checks. Strunk questions why a CU should return checks, which costs the member a $20 NSF, and then an additional fee from the creditor the check was going to. With credit card late fees averaging $34, members could be hit with over a $50 loss for writing a bad check. It could be much more for a bounced mortgage check. Strunk says bouncing checks only hurts the member and the credit union, and it is decreasing not increasing a CU's fee income. He says CUs need to start paying these checks, still take in a $20 fee (now called an overdraft fee instead of NSF), but spare the member the creditor fee, a hit to their credit reports, and the embarrassment of bouncing a check. But isn't this just rewarding bad behavior? "These are not bad people. They live pay check to pay check like 95% of the U.S. population. The problem with executives of credit unions is they were all taught in this business that people who write NSFs are not good people. That's just not true," said Strunk. "The old stigma has to go away." Strunk says the `people living paycheck-to-paycheck theory' isn't just for low and median income Americans. "It's across all income levels. Doctors, attorneys, painters, policemen, all are living paycheck to paycheck," he said. Strunk says forget the philosophy and look at the numbers. His company has helped about 540 credit unions and banks launch overdraft programs. Ask them he says, and you'll find that about 20% of members write NSFs all the time, yet the funds needed to pay those checks make it into the CU about four to five days after the NSF, so these are not members out to stiff the CU. "These are not criminals. They're looking for a little break some times. Why not give it to them?" These 20% of members can bring in a lot of fee income. Looking at Strunk clients about three years after they have launched overdraft protection finds at an institution with an average of about $208 million in assets, fee income increased 104% (see chart).Strunk said these astronomical numbers are not fiction, they are fact, and he invites any CU exec talk to other CUs that have done it or look at the data across the board for proof. "By bouncing all these checks we've created another industry, payday lenders and check cashers. They're filling a void for $100 to $500 loans that credit unions could fill by paying these checks," said Strunk. Strunk says the benefits of not bouncing checks to the CU are very significant. The credit union gets in the good graces of members who tend to write bad checks, and the fee income from overdraft protection will exceed their NSF income, which is the largest source of fee income for credit unions. It worked at the $2.6 billion Security Service FCU in San Antonio. Security Service FCU EVP Jim Laffoon said the CU saw a significant revenue increase over the first two years its overdraft program was launched. "We have seen increased revenue, although that wasn't our primary objective. I think the bottom line is there are very few win-win scenarios, but this is one of them. You have to recognize that there are certain members who are going to live their lives this way. We've found somewhere between eight to 10% of our members will utilize overdraft sometime in the year," said Laffoon. That's a lot of members given that Security Service serves 475,000 people. Security Service will pay the bad check; charge a $20 overdraft fee; and continue to do so for a member as long as they bring their account to a positive balance in 30 days. "For members who to utilize this, they have other alternatives. They can got get a pay day loan or utilize a pawn shop," said Laffoon, but a $20 overdraft fee from the CU will always be cheaper than those alternatives. So why is this not a slam dunk product that all CUs should offer? Laffoon said though it's been successful, it was a tough decision for Security Service when it implemented the program five years ago. "We're in this business to not only meet member need, but to build good member habits to help them reach their goals. Putting in a program to encourage members to write more NSFs than they would, could seem counterproductive," said Laffoon. "But we sill believe the program is very valuable for members. They consider it a tremendous value." He noted that area banks we're doing it, so competitiveness was another reason the CU got into it. Laffoon said the program is not without risk, there is about a 6% loss ratio. Interestingly, Laffoon said the good thing was that the actual losses were consistent with the figure the consultant firm that got it started in overdrafts, Strunk & Associates, said it would be. Strunk himself said 6% is a typical loss ratio for an overdraft program. But any credit union that thinks it can overnight flip a switch and start offering overdrafts is sadly mistaken, said Mike Moebs, chairman of Moeb$ Services, Lake Bluff, Ill., another consulting firm advocating CUs get more active with overdrafts. Moeb$ Services conducts the Annual Report on Retail Fees and Services that goes to Congress. Moebs emphasized that there have been legal battles dating back all the way to 1918 and as recent as today dealing with overdraft protection. "There are 13 statutes and 127 court cases that pertain to overdrafts. Most credit unions don't even fathom this," said Moebs. He said NCUA's part 701.21 gives CUs some authority to do this, but CUs have to be very careful about structuring the program. He said banks really have no regulatory authority; they've relied on courts and court precedents. Moebs said regulators are very strict on overdraft programs. They have no problem with them if done right, but any gaps and they will come down hard. He said that CUs involved in overdrafts are even beholden to the Federal Trade Commission thanks to the Patriot Act and Gramm-Leach-Bliley. "The Indiana Financial Department recently issued a scathing letter, saying you better be careful about these programs. If you don't design them right, and they're a loan program, we're going to judge them as a loan product," said Moebs. Moebs said the most important thing is first structuring the program to be a deposit program, not a loan program. If it's constructed as a loan program even more regs come into play and CUs will have to include Annual Percentage Rates on each member's monthly share draft statement. "Some of the APRs on very low balance share draft accounts would show 400, 600 or 800% APRs for the month, making the credit union look the same as the payday lender. Having this as a deposit program is extremely important," said Moebs. In order for it to be a deposit program, a CU has to charge the same for an NSF and overdraft fee. If they differ, it lends itself to becoming a loan product, said Moebs. Moebs said ideally the CU will have some empirical data backing up an overdraft draft program. In other words a CU can't just willy nilly decide to pay this check, and return that check and round and round. With no empirical data, the CU is opening itself up to a lawsuit. Credit unions need to look at credit scores, demographic data and other information to set amount levels for overdrafts. He said there can of course be some judgment as well, but data should still be there as a baseline. Moebs said a program that only pays up to say $500 isn't good enough, because $500 is less than many members' mortgage payments, probably the most important payment a member is concerned about making. "Low balance systems don't work. Here's where a credit union can use the scoring technology that is available out there," said Moebs. Moebs said it's no secret that fee income is crucial for CUs. Total non-interest income represents 97% of a CU's net income. "If they don't increase fee income, they don't have net income. If they don't have net income, they have no ability to grow because they need those reserves," said Moebs. He is not advocating that CUs go out and increase their NSF and overdraft fees. Quite the contrary. He thinks they should be lower than banks, and CUs would still bring in more fee income than they were prior to overdrafts. Unfortunately, said Moebs, CUs have been increasing their NSF/overdraft (the two fees are looked at together statistically) fees, even faster than banks have been increasing them. "If I could line up all the credit unions in the U.S. and say one thing they should stop doing it is stop raising the price on NSFs and overdrafts," said Moebs. Credit union NSFs/overdraft fees have increased from just $16 in 2000 to a median of $20 today. Banks charge more, but only $3 more at a $23 median NSF, and their rate of increase has been slower over the last two years. "Credit unions have seen what the banks are making on this and have increased their prices. I have a hard time with by how much. It makes me sad to say but I've got the evidence, many credit unions are charging more than local community banks," said Moebs. [email protected]

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