Even as regulators crack down on abusive mortgage and credit card practices, another type of lending threatens to mire consumers in a credit trap.
It's called "courtesy overdraft" and has long been used by banks to automatically pay transactions that account holders don't have the money to cover — and then charge them a steep fee. For years, banks have made it easier for customers to overdraw their checking accounts, aided by a cottage industry of consultants who make big money by helping to wring fees out of consumers, a USA TODAY analysis finds.
But what began as a customer service has often become an important revenue driver for banks at the expense of the most vulnerable consumers, according to bank memos reviewed by USA TODAY and interviews with industry insiders.
"This practice has gone awry and needs to be fixed," says Alex Sheshunoff, a key consultant who once advised banks to pay, not return, overdrawn transactions. "This is something everyone should be trying to find a solution to, not fighting."
Today, each of the nation's 10 largest banks allows consumers to overdraw with checks, debit cards or at ATMs, a 2009 USA TODAY survey reveals. Large banks also reserve the right to process large transactions first, triggering more overdraft fees by emptying the account more quickly. Some even charge consumers before they overdraw by deducting a purchase when it's made, rather than when it clears, pushing the account into the red sooner.
President Obama signed legislation in May limiting certain credit card practices — such as rate increases on existing debt — that have pushed consumers deeper into distress in a sliding economy. The government also wants to create a consumer protection agency to supervise loans. Meanwhile, the Federal Reserve is examining the fairness of certain overdraft practices.
It's unclear whether those efforts will be enough to rein in overdrafts, now the single-largest driver of consumer fee income for banks. In 2009, banks are expected to reap a record $38.5 billion from overdraft fees, nearly twice the $20.5 billion they stand to collect from credit card penalties such as late and over-limit fees.
Banks say consumers can avoid overdrafts by keeping track of their money. Consumers contend, though, that banks' policies make it challenging to avoid fees.
Faith Gordon, 48, recently sued BB&T bank for allegedly "delaying and rearranging" transactions to maximize overdraft fees. Gordon, of Atlanta, says banks should change their practices and "be fair to us customers."
BB&T spokesman Bob Denham says the lawsuit "lacks merit." The bank "categorically (denies) delaying the posting of items to create overdrafts," he adds.
Eric Halperin of the Center for Responsible Lending says regulators should examine bank overdraft rules because they "parallel" much-criticized card policies. Banks are raising fees and imposing similar policies on checking accounts and credit cards, such as charging more for multiple transgressions. The Federal Deposit Insurance Corp. says if banks cover a $20 purchase and charge a $27 fee, the loan has a 3,520% annual percentage rate (APR) if paid back in two weeks.
Senate Banking Committee Chairman Chris Dodd, D-Conn., said if the Fed doesn't curb overdraft abuses, he'll "pursue legislative action." Rep. Carolyn Maloney, D-N.Y., has sponsored legislation requiring banks to get consumers' permission to cover overdrafts, disclose APRs and pay transactions in a way that doesn't increase fees.
Banks are lobbying heavily against restrictions. Why? "Overdraft fees are the mother lode of (deposit) fees," says Michael Moebs of Moebs Services, an economic research firm. "If it weren't for overdraft fees, 45% of banks and credit unions wouldn't have made money in 2008."
As consumers rein in spending during the recession, overdraft income is growing at a slower pace. But it's growing nonetheless as large banks — many of which received billions of dollars in government aid — get more aggressive about fees.
Wachovia, for instance, is discouraging employees from refunding overdraft fees. A 2007 bank memo obtained by USA TODAY tells employees that the fees "make up a big percentage of our revenue and is (sic) a HOT button among leadership." Wells Fargo, which owns Wachovia, says it educates customers but also has a "responsibility to shareholders" to collect overdraft fees.
Bank of America now allows consumers to overdraw 10 times a day, up from five last year. Even so, the bank is charging a lower fee if consumers overdraw by less than $5 a day. Spokeswoman Anne Pace says the bank wants to help customers but must adjust policies if costs rise.
Yet Brad Nickum, a consultant who advised some of the largest banks on credit card and overdraft income, says profits — not costs — generally drive bank fees. "We've got this bastardized revenue stream that gets a disproportionate amount from a small portion of the customer base," Nickum says.
The 10% of checking accounts with the lowest balances generate about 40% of overdraft revenue, estimates Andrew Dresner, a partner at payment consulting firm Oliver Wyman.
Sarah Davis, 25, paid $600 in fees over three days because of a smaller-than-expected paycheck and her bank's policy of allowing repeated overdrafts. She says she understands that banks need to make money. But "when (the policy) starts to affect the people working minimum-wage jobs, then it's not the most socially responsible," says Davis, a part-time employee at a bookstore.
Scott Talbott, chief lobbyist for the Financial Services Roundtable, representing large banks, says it's "unfortunate that low- and moderate-income Americans find themselves (using) overdraft services more often."
But when banks pay overdrafts, consumers can save money, Moebs says. That's because some merchants charge for returned checks. The penalties, along with banks' own charges, can cost more than the fee levied if the bank paid the transaction.
Banks also point out that consumers can sign up for less-expensive overdraft services such as a transfer from savings.
Moebs fears that if banks are restricted from charging overdrafts, some may go out of business while others could bounce overdrafts, marring consumers' credit records.
Overdrafts weren't always such a profit center. Some banks used to sort through bounced checks daily, figuring out which to cover based on their relationship with customers. Others refused all overdrawn transactions.
In the 1960s, Gerald F. Fitzgerald, founder of Suburban Bancorp of Palatine, Ill., was one of the first to begin paying more overdrawn transactions rather than bouncing the checks. He says he did so as a service to "good" customers.
The trend gained momentum in the 1990s when banker Sam Davis joined Strunk & Associates consulting firm. He looked into how banks could profitably extend small-amount loans to consumers. In 1996, the firm rolled out software nationwide that made it easier to automatically pay overdrafts. Firms such as Pinnacle Financial and John M. Floyd marketed similar programs.
Also in 1996, a Supreme Court decision and a bank regulatory rule effectively gave the industry authority to raise certain fees as much as they wanted. A new law forced some government benefit recipients to set up electronic deposit. Direct deposits made overdrafts less risky because banks could recover debts on consumers' next pay day. The Truth in Lending Act, signed into law in 1968, sanctioned overdrafts, Moebs says, by defining them as credit, but not as loans subject to disclosures about interest rates.
These events created "fertile ground" for overdraft-fee abuses, which consulting firms spread through the industry, says Chi Chi Wu of the National Consumer Law Center.
Some consultants offered banks ways to boost overdraft and credit card revenue. A 2001 "checklist" from Profit Technologies — a firm that has worked with 19 of the USA's 20 largest banks — has more than 600 strategies. Some are cost-cutting ideas such as printing a dispute form on the back of credit card bills to curb phone calls.
But most relate to income from fees. One strategy listed to boost overdrafts: "Allow consumers to overdraw their ... accounts at the ATM up to the bank's internally set limit." To increase credit card fees, banks can "delay crediting of payments not received in bank provided envelop (sic) or for which payment coupon is not received for up to 5 days," and "remove bar coding from remittance envelopes," slowing the payment.
Patrick Fox, president of Profit Technologies, says the document USA TODAY obtained "look(s) like our work." The list, he adds, is a "collection of (bank) practices," but the firm doesn't necessarily recommend each one.
Still, the practices confirm consumer groups' greatest fear. "We always thought what (the industry) was doing was deliberate. Now we know it is," Wu says.
Because consultants typically make money when banks do — firms take up to one-third of banks' first-year profits on a recommendation, court records show — they have incentive to pitch aggressive fee strategies.
In the 1990s, Earnings Performance Group, a consulting firm, estimated PNC boosted its revenue by about $7 million a year when it took the firm's advice to pay more overdrafts, court records say. PNC later sued EPG, saying another overdraft strategy failed to yield an additional $5 million a year, as promised.
Gerald Smith, a founder of EPG, which closed last year, says PNC calculated the benefits "incorrectly" and wouldn't let the consulting firm check the results.
Smith says that while some consulting firms and banks are too aggressive with overdraft policies, EPG tried to recommend plans that were "fair" to customers but would bring the "most revenue" to banks. Davis of Strunk & Associates says courtesy overdraft is a "value (consumers) are very willing to pay for."
Yet E. Adam Webb, an Atlanta lawyer who has sued several banks, says consultants pushed banks into "a race to the bottom" with overdrafts. "These fees have gone through the roof because of all the tactics they use," he says.
Banks also have their own employees working to find new fees. Jake Drew, a former vice president in MBNA and Bank of America's "revenue-optimization" group, worked for nearly 10 years with a dozen others implementing credit card policies. Based on this experience, Drew believes regulators need to limit what banks can do — rather than saying what they can't do.
"Banks have thousands more resources to come up with other revenue-generating ideas," says Drew, who was fired this year for refusing to sign an employee agreement governing ownership of his work. Bank of America declined to comment.
Fox says the industry shouldn't apologize for strategies that benefit shareholders: "Let's not be naïve. Banks are doing things to make money."
Has banks' pursuit of profit gone too far? Ken Vollmer, 49, of Augusta, Ga., thinks so. He sued Wachovia this year, alleging it "purposely structured transactions to make money." A merchant mistakenly put a hold on his funds, then the bank cleared transactions from high to low, triggering hundreds in overdraft fees, he says. Spokeswoman Richele Messick says Wachovia processes transactions in an "appropriate" way and will "vigorously defend" itself in the case.
Banks clear larger payments first, says Talbott, because they tend to be more important. But Douglass Colbert, who advised banks on overdraft and card strategies at Profit Technologies, says fees are a key driver.
"Banks will say (high-to-low clearing) is for the consumer," he says. "Bottom line is, when it was pitched, we'd say ... a side effect is that it results in more fee income to you because it bounces more checks." Colbert says that after leaving Profit Technologies, he joined a credit-counseling firm and saw the damage fees did to consumers.
Sheshunoff says overdrafts have become abusive and merit tight regulation: "Overdrafts started happening too easily. I'm very apologetic that it morphed into what it (did)."