Fully disclosed courtesy pay programs can help credit unions serve members and their own bottom lines.

Shrinking margins, increasing regulatory burdens and new rounds of contributions to the Corporate Credit Union Stabilization Fund, are all placing pressure on the bottom line of every credit union. As the industry works through budgeting and planning sessions for the coming year, many credit unions are looking at their net interest income and non-interest income for opportunities to offset, or at least diminish, the erosion of their net income.

The business of credit unions is recognizing member needs, offering services to meet those needs, managing the risk associated with the service, and making a profit from those services to invest in the credit union’s future. That’s exactly what a fully disclosed courtesy pay program helps credit unions do: serve both members and their organizations’ bottom lines.

What is Courtesy Pay?

Courtesy pay is the way a credit union handles an item presented for payment that is going to take a checking account negative (also known as overdrawing the account). Rather than denying payment of an item and sending it back to the merchant, many credit unions offer some type of courtesy pay. Credit union directors need to understand that this service can come in one of two forms:

A) Non-disclosed courtesy pay programs are limits set up in the data processing system allowing it to take an account negative up to a limit based on certain criteria. The criteria may be different from one credit union to another or from one account to another, but they are typically based on the member’s average account balance, average monthly deposit, and how long the account has been open. Members who have higher balances or higher monthly deposits generally get a higher overdraft limit. Those with lower balances get lower limits or no limit at all. This type of courtesy pay program is generally an operational solution to paying overdrafts and is not in the best interest of the member. Many times, the member in need of the overdraft payment service receives no limit at all!  Also, the member knows nothing about this type of program such as what their limit is or how it saves them the hassle and embarrassment of having an item returned.  These types of programs are not transparent when it comes to disclosing the features and benefits of a service the credit union provides.

B) Fully disclosed courtesy pay programs make sure the member knows about the features and benefits of the credit union’s payment of items that overdraw checking accounts. The limit, the time to repay, the fee, and the repercussions of not paying the overdraft back are fully disclosed, giving members complete control over their checking account. The current regulatory environment encourages clear and transparent disclosures on all financial products, including courtesy pay.

The board of directors needs to understand which type of program, if any, your credit union offers.

Benefits of Fully Disclosed Program

A) Non-disclosed overdraft payment programs are generally one-sided transactions. They benefit the credit union by obtaining higher amounts of fee income associated with overdrafts. The members and employees of the credit union generally know nothing about the service; therefore there is very little relationship building as a result of the program.  An overdraft fee can be charged in lieu of a returned check charge (usually the same fee whether a CU pays or returns an overdrawn item).  Overdrafts are disclosed in the member account agreement when they sign up for a new account.

B) Because fully disclosed overdraft payment programs give the members complete knowledge of the service, the credit union strengthens its relationship with members by having this kind of program. With a fully disclosed program, members know what savings they can get paying program fees rather than returned check charges, plus they can participate fully in managing their account, including “opting out” of the service at any time, should they wish to.

The board of directors needs to make sure any program the CU offers is beneficial to both members and the credit union. Interestingly, a fully disclosed program can generate an additional $40 per account in additional fee income if implemented correctly. Members who know that a credit union offers a courtesy pay program will be less likely to go to a pay day lender or check casher for their short term cash needs.  It is much simpler to write the check and pay the fee to their financial institution than it is to go somewhere for money.  This may seem cruel and a tough way to live but a certain percentage of us live that way…pay check to pay check…and offering courtesy pay in a fully disclosed manner keeps the members who use this service from leaving our industry.

Courtesy Pay Under Scrutiny

The primary cause of recent scrutiny and increased regulation regarding courtesy pay resulted from some institutions’ undisclosed overdraft program practice of making internal overdraft limits part of their debit card/point of sale authorization balance. This “bump the balance” practice allowed transactions that had previously been denied to be paid and charged an overdraft fee without account holder notice, any disclosure and, in a number of cases, inability for consumers to opt out. For example, some institutions’ stated ATM balances used to include the actual balance the member had in the account ($100) plus a predetermined “overdraft balance” ($500), giving members the impression they had $600 in their account. If they then withdrew $200 from the ATM, they were charged an overdraft fee!

A large amount of negative publicity surrounding all overdraft programs resulted from media stories of the “$35 cup of coffee” (low-dollar-amount transactions subject to an overdraft fee) and lack of disclosure and transparency of overdraft practices driven by a relatively few, but usually large, financial institutions. Such issues led to revisions to Regulations DD and E and additional guidance from regulating agencies, and generated concern for institutions related to reputation risk associated with offering courtesy pay or having an overdraft/negative share process.

Credit union boards need to make sure their credit union’s courtesy pay program meets all the regulations set forth by the Federal Reserve, the National Credit Union Administration and any applicable state law or code. These are described further in the next section.

Regulations to Know

The NCUA joined other federal banking regulators in issuing Joint Guidance on Overdraft Protection Programs published in 2005 to assist institutions in the responsible disclosure and administration of overdraft protection services. These “best practices” have been positioned as minimum expectations for insured credit unions in their operation of courtesy pay. Credit unions have been encouraged to review and, as appropriate, implement best practices in the guidance. Applicable laws and regulations to ensure overdraft protection programs are fully compliant include the FTC Act, Equal Credit Opportunity Act, Regulation B, Truth in Lending Act and Truth in Savings Act disclosures. Further, the NCUA published an Automated Integrated Regulatory Examination System questionnaire in late 2005 to be used by NCUA examiners to evaluate non-contractual overdrafts. This questionnaire provides specific expectations credit unions should be prepared to address during examinations.

Recently, the Federal Reserve Board issued amendments to Regulations E and DD that all financial institutions must address regarding overdraft service delivery point consent, increased required disclosures to account holders regarding overdraft programs, and a comprehensive review of overdraft activity and fees on monthly statements.

The Question of Due Diligence

Credit unions that don’t have a discretionary overdraft program are at risk of making arbitrary and discriminatory decisions about which members get their overdrawn items paid, returned, charged and waived. Those credit unions may be exposing their members to unnecessary embarrassment, cost and inconvenience. They also may be forcing many of their members to use resources outside of mainstream financial institution offerings, such as predatory check cashers, payday lenders and others. Equally important, credit unions without a courtesy pay program are giving up a tremendous fee income opportunity.

Absent a service, credit union management should be aware of any existing operational situations where share draft accounts are processed into negative share, its inherent risk and how it is addressed, as well as the potential impact to the member and credit union.

NCUA’s AIRES payment of overdrafts questionnaire has been used by examiners to evaluate non-contractual overdrafts and also served as a tool for credit unions to use in evaluating their individual courtesy pay or bounce protection programs. Credit union boards can use this questionnaire as part of the framework for ensuring that they and their managers are meeting examination and supervisory oversight expectations. Policies, disclosure and communication, accounting, third-party service providers, reputation and compliance risks are addressed in this process.

In addition to the AIRES questionnaire, board members should monitor and document their oversight of management’s determination of appropriate overdraft limits, fee structure, waiver and refund practices and policies, and adherence to recent changes to Regulations DD and E. Boards should ask managers what efforts are in place to monitor and address any current litigation other financial institutions are experiencing relating to overdraft payment processes.

Reputation at Risk

Any practice or product that has the potential to lead existing members to close their accounts or potential members to refrain from joining a credit union should be monitored in a disciplined and documented manner. Regulators have specifically identified deceptive and misleading practices, lack of clear disclosure and explanation of operation, and the costs and limitations of overdraft programs as concerns in the industry. These concerns are especially relevant to courtesy pay due to negative publicity surrounding all overdraft services.

At the core of any good service offering there is clear product disclosure, consistent internal operations and continuing member education. Within that framework, boards should ask their managers if they are addressing reputation risk of overdraft services by an annual review of key features and operation; disclosures used to explain to members the operation; costs of the service and the responsible use; staff education of program features and other choices; clear balance disclosure of all overdraft services; and excessive usage monitoring.

With net interest margins declining, due to a reduced amount of lending; increases in NCUA insurance premiums and compliance costs; and fee income from insurance and cards threatened, credit unions can benefit from offering a fully disclosed courtesy pay program. Fully disclosed overdraft payment processes, done correctly, provide maximum choice to the member and add much-needed fee income to the credit union’s bottom line.

Mike Sobba is president/CEO of CUES Supplier member Strunk and Associates (http://www.strunklp.com),Houston,Texas. Strunk helps financial institutions remain competitive and sustainable over time, including offering turnkey overdraft privilege and value checking solutions.

Questions (Apply it to your Board Room):

How does our credit union currently handle member overdrafts?

Do our members appreciate how their overdrafts are handled?

Does our credit union benefit from how our overdrafts are handled?

How could our members benefit from a fully disclosed overdraft pay program?

How could our credit union benefit from a fully disclosed overdraft program?

In thinking about what risks there are with overdraft programs of various types, it is important to look back at last year in terms of major developments.

Enhanced guidelines and best practices were offered by the FDIC over a year ago, along with conference calls to clarify the guidance. Then in June of 2011, the OCC offered substantially different guidelines, which have yet to be made official at this writing.  The CFPB has often said that overdraft programs will be squarely in their sights, and the recent recess appointment of a new Director and his appointment’s questionable legality adds nothing but confusion to the mix. The result of all of this flailing is a substantial level of inconsistency and confusion, not only among banks, but among examiners as well.

One of the most notable developments of last year was the consolidation of over thirty lawsuits against financial institutions regarding their overdraft programs into a Multidistrict Litigation to be heard by a Florida Federal Court.  While these cases are currently wrestling with largely technical issues, no less than seven institutions have settled out of court prior to any actual litigation of the facts.  Those seven banks have settled for a total of almost $500 million.  To that particular set of banks, that outcome is already a much more serious reputation risk issue than a financial issue.

Those banks were not singled out because they offered overdraft programs, but because they were perceived to have triggered the relatively new trip-wire of UDAAP (Unfair, Deceptive, Abusive Acts and Practices) regarding the manner in which they artificially arranged the presentment of various transactions against a consumer’s account in order to maximize fee income.

The vast majority of banks do not engage in that kind of behavior, but I would suggest that the UDAAP trap could be sprung by any substantive difference between what a bank discloses about its overdraft program and its actual day-to-day practices.

Over the past decade, the three things that have gotten banks in the most trouble have been:

1. “Bumping the balance” – Consciously or otherwise, allowing the customer’s actual balance to be inflated by any overdraft facility.  That’s about as “unfair and deceptive” as you can get.
2. Paying “High to Low” – A case can be made for different approaches, but the regulatory guidance over recent years clearly increases the risk of a bank who clears debits in that order.
3. Lack of transparency and the fullest possible disclosures.

The things that must be considered in order to manage regulatory risk in the coming year (in my opinion) are:

1. Establish “caps” on fees and have meaningful procedures to ensure that those processes are consistent and non-discriminatory.
2. Implement a “de minimus” cushion to avoid charging fees on small items.  The “$35 cup of coffee” argument needs to be taken off the table.  Run your numbers and determine the potential impact of your decision – don’t just “pick a number”.
3. Determine what should be done with the habitual “overdrafters or abusers” of your program.   How are these customers going to be identified and how will you communicate alternatives to them?
4. Provide meaningful management information regarding your program that receives attention all the way up to the board of directors.

If some of the largest financial institutions in the country can’t get it right, with their almost unlimited resources, how can your bank assure ongoing compliance in this atmosphere of confusion and regulatory inconsistency?  Strunk & Associates is the original developer of the discretionary overdraft program and has almost twenty years of experience.  Strunk has put its program and compliance support in more than 1,760 financial institutions, and we’d be happy to help your bank navigate the risk management minefield.

No bank can be fully successful without an effective overdraft program that strengthens fee income and provides bank management with up-to-date guidance, best practices, and reporting that ensures consistent oversight.  Let us help your bank with a free review of your overdraft program.  Please call me, or check out our new website at www.strunklp.com.

Mike Sobba
President & CEO
Strunk & Associates, L.P.

Download Mike Sobba’s letter,  Managing Risk, in Microsoft Word Format.