Bank of America, JPMorgan Face More Overdraft Pain (Update 1)

Updated with analyst commentary.

NEW YORK ( TheStreet) -- -- Bank fee income, already under pressure from a host of new regulations, might be further threatened by the Consumer Financial Protection Bureau's latest probe into overdraft practices.

Overdraft fees have already declined for the industry following the implementation of a rule under Dodd Frank called Regulation E in 2010, that mandated that banks make customers opt in for overdraft protection instead of enrolling them by default.
Consumer Financial Protection Bureau Director Richard Cordray

U.S. bank overdraft fees have dropped 20% from $37 billion in 2009 to $29.5 billion in 2011 according to industry consultant Moebs Services. The decline came even as banks moved to raise the average overdraft fees by as much as $4 to $30 over the two- year period.

Still, the CFPB is targeting overdraft practices once more. "Overdraft practices have the capacity to inflict serious economic harm on the people who can least afford it," CFPB director Richard Cordray said in a statement on Wednesday as he announced the bureau's latest inquiry. "We want to learn how consumers are affected, and how well they are able to anticipate and avoid paying penalty fees."

One practice the bureau is zooming in on is the processing of orders starting with the largest first rather than chronologically, thus allowing them to charge fees on a number of small transactions. Banks have claimed that they process large transactions first because customers likely deem them more important.

The bureau will also look into how banks disclose overdraft terms and whether customers receive misleading information about overdrafts, noting the difference in the opt-in rates of overdraft fees between banks.

Banks have been on marketing overdrive since the passing of Reg E, urging customers to opt-in for the overdraft protection to avoid the embarrassment of being denied a purchase or worse, being unable to spend in an emergency situation because of an empty bank balance.

But consumer advocates say the fees are still too high at an average of $35 and that they unduly hurt low-income and young customers.

For the biggest banks including Bank of America ( BAC) , JPMorgan Chase ( JPM) and Wells Fargo ( WFC), the renewed scrutiny on overdraft fees is certainly unwelcome, especially as they struggle to make up for lost revenues from not just Reg E, but also from the Durbin Amendment, which limits the amount they can charge merchants for processing debit card transactions.

Bank of America took a $430 million revenue hit in the fourth quarter of 2011, due to the effect of the Durbin Amendment and has estimated an annual revenue loss of $2 billion from the rule.

JPMorgan Chase estimates that the debit interchange rule hurt revenues by $365 million in the fourth quarter of 2011. It expects the rule to adversely affect the bottom line by $600 million in 2012.

Precise estimates of revenue loss due to the overdraft rules are unavailable. But most of the big banks, with the exception of Citigroup ( C) due to its higher share of foreign deposits, saw a big drop in service charges on deposits in the fourth quarter of 2010, the first time the overdraft rules were in full effect. Most of the service charges come from overdraft fees.

Bank of America saw a 36% drop in service charge on deposit accounts in the fourth quarter of 2010 to $1.28 billion, according to data from the Federal Reserve provided by Highline FI. JPMorgan Chase saw an 18% drop on a year-on-year basis to $1.12 billion. Service charges for Wells Fargo declined 27% to $1.03 billion, while PNC Financial Services ( PNC) fell 28% to $244 million.

The probe appears to broadly aim at improving disclosures, but any moves to restrict how banks charge overdraft fees could see this revenue stream dwindling further.

Banks have tried to offset the revenue impact from new regulations by charging customers fees for debit card transactions, but their efforts have backfired. Bank of America felt the heat of a nationwide backlash last year when it attempted to slap a $5 monthly fee on debit card purchases and finally had to withdraw its proposal. JPMorgan Chase, Wells Fargo and other regional banks also abandoned similar plans.

Companies continue to argue that it costs nearly $300 a year to provide all the facilities that come with a checking account and that they have little choice but to charge customers more in the face of shrinking revenues. And critics of Dodd Frank argue that the unintended consequence of such regulations as Durbin and Reg E will be that banks will find a way to charge customers more fees.

But they may have a hard time doing that with the CFPB closely monitoring the way they charge customers for their services.

Bank of America Merrill Lynch analysts believe that a key risk to their 2012 estimates is that banks fail to recoup any of the lost revenue. "Interestingly, after being vocal about mitigation during second quarter and third quarter conference calls, regional banks were far more restrained about addressing fee mitigation goals," the analyst noted in a report Thursday. "Recent conversations with bank management teams indicate that they are focusing more on "account growth" rather than "nuisance fees" - leading us to believe that there could be danger to our estimates."

Together with a prolonged period of low interest rates that depress income from lending and persistent weakness in capital markets that hurt trading revenues, and more scrutiny over big M&A transactions, banks have little avenues to generate revenue growth.

And without strong visibility on earnings, it is hard to imagine the strength in bank stocks witnessed in recent weeks lasting through the rest of the year.

-- Written by Shanthi Bharatwaj in New York

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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