Dodd-Frank Round-Up: Where We Are and What Needs to Be Done

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future-signs.jpgIt’s been two years since the Dodd-Frank Act was passed, and regulators have published 8,800 pages of regulations ironing out the details of the law. Many rules still have not been written, leaving huge portions of the Act in limbo. This article takes a look at the status of major pieces of the legislation with an eye towards the impact on commercial banks and the banking system.

1. SYSTEMIC RISK

About: The recent financial crisis highlighted risks taken by individual companies in a highly interconnected financial sector. Dodd-Frank established a framework for monitoring and regulating this systemic risk. 

Past Developments: The newly created Financial Services Oversight Council released its final rule for designating nonbank systemically important institutions. The top banking firms recently released their “living wills,” or plans to unwind themselves in the event of failure without government or taxpayer assistance. 

Future Developments: The Federal Reserve will finalize capital requirements for large institutions as well as the specific rules for implementation of Basel III, an international agreement that strengthens capital requirements and adds new regulations on bank liquidity and leverage.

—From: Weil, Gotshal & Manges LLP, “The Dodd-Frank Act: Two Years Later,”  For access to their full report, click here.

 

2. THE DURBIN AMENDMENT

About:  The Durbin Amendment part of Dodd-Frank, which caps debit card interchange fees for banks above $10 billion in assets, has likely had the greatest immediate impact on the banking industry, as it went into effect in October of last year.

Past Developments:  The impact on banking revenues has been swift. The industry reported a $1.44 billion loss of revenue in the fourth quarter of 2011, resulting in an annualized $5.75 billion loss if this pattern holds, according to Novantas LLC, a New York City-based consulting firm.

Future Developments:  It is still uncertain whether banks under $10 billion in assets will be able to charge more for debit card interchange than bigger banks in the long term, but so far, the smaller banks haven’t reported a loss of income in aggregate.

3. COMPENSATION

About: Dodd-Frank requires institutions to show that their incentive arrangements are consistently safe and do not expose their firms to imprudent risk. 

Past Developments: The Securities and Exchange Commission implemented rules last year requiring publicly traded companies to take advisory shareholders votes on executive compensation, also known as “say on pay.” It also implemented rules on the independence of compensation committees and compensation advisors, as well as on “golden parachute” payments to executives.

Future Developments: Dodd-Frank included a provision that instructed agencies to issue guidelines on incentive compensation. Although proposed more than a year ago, they have not been finalized.

—From the Securities and Exchange Commission and Deloitte LLP’s “Dodd-Frank Act Two-Year Anniversary: Seven Takeaways on Dodd-Frank’s Impact on Compensation.”  For access to their full report, click here.

4. CONSUMER FINANCIAL PROTECTION BUREAU

About:  The CFPB is the first federal agency focused solely on consumer financial protection, and it holds responsibilities previously managed by several other regulators.  The CFPB has examination authority over banks, thrifts and credit unions with $10 billion or more in assets, as well as some large nonbank financial service companies that previously escaped federal regulation, such as payday lenders.

Past Developments: With a new director in place, the CFPB has not simply been implementing rules it inherited from other regulators, but promulgating many new, substantive rules. 

Future Developments: Further rulemaking may help illuminate the meaning of “unfair, deceptive and abusive” acts and practices, which the CFPB is tasked with eliminating, especially in the context of mortgage servicing and origination. New mortgage disclosure documents are in the process of being finalized.

—From Weil, Gotshal & Manges LLP,  “The Dodd-Frank Act:Two Years Later.”  For access to their full report, click here.

5. MORTGAGE ORIGINATION AND SERVICING

About: Dodd-Frank amends the residential mortgage portions of several federal housing statutes. Among other things, mortgage originators now owe a duty of care to borrowers.  

Past Developments: Creditors are now required to make a reasonable and good faith determination that a consumer has a reasonable ability to repay a residential mortgage.

Future Developments: The CFPB is considering rules to implement provisions of Dodd-Frank that would address mortgage loan originator qualifications and compensation. 

—From Morrison & Foerster’s “Dodd-Frank at Two.”  For access to the full report, click here.

6. DERIVATIVES

About:  The Dodd-Frank Act is designed to provide a comprehensive framework for the regulation of the over-the-counter derivatives market to provide greater transparency and reduce risk between counterparties.

Past Developments: The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have both been missing statutory deadlines.

Future Developments: It is yet to be determined specifically how these provisions will be applied across borders and to what extent they will cover U.S. operations of foreign firms. 

—From Deloitte LLP’s “Dodd-Frank Act Two-Year Anniversary: Five Takeaways on Dodd-Frank’s Impact on Derivatives.”  For access to their full report, click here.

7. THE VOLCKER RULE

About: The Volcker rule prohibits banks and bank holding companies from engaging in proprietary trading or owning private equity and hedge funds, with some exceptions. It is considered one of the most controversial aspects of Dodd-Frank.

Past Developments: The Fed, FDIC, OCC, and SEC jointly issued the proposed rule, which further defined key terms such as “banking entity,” “proprietary trading,” and “covered fund,” as well as outlining exceptions to the rule’s prohibitions.  If proposed in its present form, many investment products having nothing to do with private equity or hedge funds will be prohibited.

Future Developments: Lawmakers and regulators are pushing for the final rule by the end of the year, but affected financial institutions will have until at least July 21, 2012 to conform to the rule.

—From Weil, Gotshal & Manges LLP, “The Dodd-Frank Act: Two Years Later.”  For access to their full report, click here.

8. CAPITAL REQUIREMENTS

 About: Based on “lessons learned” from the financial crisis, regulators are examining more critically the quality of capital held by U.S. banking organizations as well as credit risks. 

Past Developments: In early June 2012, the U.S. banking agencies published for comment a series of three regulatory capital rulemakings in accordance with the international Basel III agreement, two of which would substantially revise the current regulatory framework. Comments on the proposals are due September 7.

Future Developments: Many of the new capital guidelines and rules haven’t gone into effect and will be gradually phased in over a period of a year or up to a decade, depending on the size of the bank and the rule.

—From Morrison & Foerster’s “Dodd-Frank at Two.”  For access to their full report, click here.

Boosting Income Without Losing Customers

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The Durbin amendment and new overdraft rules significantly cut into fee income, creating more unprofitable accounts. So what should banks and other financial institutions do to generate more fee income? StrategyCorps’ managing partner Mike Branton talks about how financial institutions can increase fee income from these accounts without scaring off profitable customers.

What are banks doing today to get more checking-related fee income?

There are three camps. One camp continues to do nothing. Maybe they think overdrafts are going to make a comeback.

Another camp is doing what we at StrategyCorps call “fee-ectomies”—charging for things banks have been giving away for free or relying on past tactics like balance requirements with penalty fee (maintain a $500 minimum balance or be charged $6). These fee-ectomies are perceived as unfair by customers—paying fees while adding nothing of value. Economists describe this as “an unfair value exchange.”

The third camp recognizes that consumers have been trained to value traditional checking benefits at zero due to free checking; that perceived fairness drives customer reaction to fees; and that you must not make the same checking account changes across the board with no recognition of the individual customer’s existing relationship profitability with the bank. We think the third camp will be the winners financially and with their customers.

What specifically is this third camp of banks doing?

These banks have first found a way to understand which checking customer relationships are profitable and which ones aren’t. Doing this allows for checking account changes to selectively fix the unprofitable ones and protect the profitable ones, rather than a wholesale change that may raise fees on every customer.

Once the banks have this identification and segmentation, the account design changes include adding non-traditional benefits if you are going to add a checking fee. Adding a fee without blending in new benefits results in customers feeling their bank is just greedy by charging for things that have been given away for so long. Think about how you feel about when airlines charge for luggage.

Third, once banks have determined the precise checking account changes to each customer segment, they should communicate these changes clearly and directly to each customer with an “upgrade” message rather than a “we need more fees but aren’t providing you any more value” message. And they train their branch personnel to understand how these changes are truly fair for the customer, so they can deal with inquiries from customers about those changes.

In a nutshell, these three things are what StrategyCorps does for financial institutions.

So I guess you don’t agree with banks or thrifts charging fees for the use of a debit card at $4 or $5 per month?

It’s insane. You’re taking the number one most convenient, most popular way that customers want to pay for something and now you start charging a usage/penalty fee for that card right at the time you need significantly greater transaction volume? This negative reinforcement won’t work and there’s consumer research showing 80 percent to 90 percent of consumers oppose this idea and 20 percent to 30 percent will change banks over it.

With the Durbin amendment (which caps debit fees at 21 cents per transaction for banks above $10 billion in assets), banks have to make it up with volume. So incentivize customers to use it more. We’ve designed our products to do this and are seeing transactions at least double. Charging a fee is going to not only tick off customers but also cause material account attrition that will offset significantly any fee lift.

Aren’t there going to be a lot of customers who say, “I don’t want to pay for a checking account?” Won’t a large number of people call the bank and say, “I don’t want the five dollar account, give me the free one?”

Actually, no. We understand this expectation and concern here by bankers, but we’ve done this account upgrade process hundreds of times. The reality is there is no appreciable negative response and minimal incremental attrition if you incorporate a fair fee-based account.

Doing this will get banks more fee income annually per account—the range is between $60 and $75—from unprofitable accounts, which is usually 40 percent to 50 percent of all checking accounts. Do the quick math; this is a significant number. The financial reward far outweighs the risk of losing accounts that were costing the bank money anyway.

And for the profitable accounts, there are several ways the relationship can be protected with this kind of “fair and upgraded” account strategy that significantly reduces their attrition risk.

Seven Ways Financial Institutions Can Maximize Profitability

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FirstData-WhitePaper3.pngIn the past, financial institutions didn’t need to rethink the way they did business. But times have changed. Between today’s unpredictable global economy and new banking regulations recently enacted, it has never been more challenging to grow revenue, maintain profits and satisfy customers.

Today, banks and credit unions need strategic solutions to replace lost revenue, reduce costs and maximize profitability. First Data has created this white paper to help you explore new ways to effectively evolve your business in today’s world.

Our white paper addresses today’s big issues and critical areas, including:

  • The Durbin Amendment: Can you maintain checking profitability, despite lost DDA revenue? 
  • Debit Strategy: How can you rethink your debit programs in order to increase the profitability of your offerings?
  • New Technology: What do consumers expect when it comes to technology? How important is mobile banking? 
  • Fraud Prevention: Can centralizing fraud management help your institution reduce fraud?

To read the white paper, download it now.

What’s Next for Consumer Checking after Durbin?

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checking.jpgThe two major checking-related fee income sources have been the targets of regulation. Durbin will decrease interchange fees by about 45 percent (44 cents per average transaction down to 24 cents). Sure, there’s still uncertainty regarding the exclusion for financial institutions with less than $10 billion in assets, but even the most optimistic banker will concede that interchange fees will not be at levels where they’ve been before. Add to that, the estimated financial impact of FDIC and OCC overdraft guidance – a reduction of an additional 15 percent to 25 percent on top of Reg E’s first year negative impact of about 10 percent to 20 percent. So, checking account products and pricing will have to change to adapt to these new rules.

These changes to replace lost fees won’t be popular, given overall consumer sentiment towards banks these days. This challenge is compounded by the fact that free checking has convinced consumers that traditional checking benefits aren’t worth paying for. In the minds of many consumers, since banks have been able to financially justify not charging for these benefits for the last decade or so, no longer doing so is just another “fee grab” by greedy banks.

This means the easy and convenient changes like starting to charge fees for the same benefits that have been free or instituting certain requirements, like minimum balances to avoid penalty fees, is a risky move. It will anger customers, especially the most profitable ones, and chase many of them away to competitors. Plus, history has proven that these kinds of checking changes will generate only a fraction of the revenue that needs to be replaced.

Banks must make changes to their retail checking accounts to incorporate a fair exchange of value with customers. This means an upgrade in what they get when their bank begins charging fees for services. Sorry to sound like a broken record, but charging fees for benefits that customers haven’t paid for in the last decade or adding requirements to avoid a fee is a tough sell, and just defaulting to this approach will be unproductive at best.

So smart banks see the post-Durbin world of checking as an opportunity to launch innovative checking products-including adding non-traditional checking benefits deemed worthy of a charge, such as local merchant discounts and identity theft protection. And look for pricing strategies that simply and immediately reward customers by reducing checking fees based on desired banking behaviors from customers that don’t revolve around minimum balances. This differently defined “pathway to free” will replace the traditional free checking account, which will be hard to justify in the future from a profitability standpoint.

Who Gains the Most From Final Interchange Rule

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The Federal Reserve’s final rule released this week on the debit interchange or “swipe” fees that retailers must pay looks like a clear victory for the banking industry, as it will allow banks to charge double what had been previously proposed.

For some, it’s more of a victory than for others. Banks that have relied heavily on debit fee income to support their business models, such as TCF Financial Corp. in Minnesota, clearly have more to gain by the change from the proposed rule. The final rule allows banks to charge about 24 cents per transaction, up from about 12 cents under an earlier proposal (both of which include a surcharge for fraud protection).

Banks, thrifts and credit unions with less than $10 billion in assets are supposed to be exempt from the new rule, but it remains unclear whether the marketplace (i.e. Visa and MasterCard) will create a two-tiered system that protects the smaller banks.

An analysis by the research and investment banking firm Keefe, Bruyette & Woods (KBW) this week says TCF Financial Corp. had the most to gain from the change in the proposed rule. If you’ll remember, TCF is the bank holding company that sued the federal government last October over the constitutionality of the interchange rule, otherwise known as the Durbin amendment to the Dodd-Frank Act.

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TCF’s stock shot up 4.8 percent from Wednesday morning to early Friday afternoon on the New York Stock Exchange, to $14.40 per share.

KBW’s analysis shows that TCF, which has $18.7 billion in assets, will make 11 cents more per share  in 2012 earnings with the change just made to the final rule, all else being equal. That basically means TCF will see its earnings cut 22 cents per share in 2012 instead of 33 cents, as previously proposed. The analysis doesn’t take into account any possible changes to fees, such as an annual debit fee for consumers, that banks may implement to make up for the loss in fees collected from retailers.

Other banks that have the most to gain from changes in the rule, according to Keefe, Bruyette & Woods, include Synovus Financial Corp. in Columbus, Georgia; Regions Financial Corp. in Birmingham, Alabama; and BancorpSouth, Inc. in Tupelo, Mississippi.

Not surprisingly, TCF announced yesterday that it was requesting permission to drop its lawsuit in the U.S. District Court in South Dakota, citing both the Federal Reserve final rule and the fact that it lost an appeal in federal court this week on the matter of a preliminary injunction.

“While we continue to believe that the Durbin Amendment is unconstitutional because it requires below-cost pricing and exempts 99% of all U.S. banks, we believe our lawsuit has served its purpose in demonstrating the unfairness of the Durbin Amendment and that it is time for us to move on,” said William A. Cooper, the company’s chairman and chief executive officer, in a statement. “The Federal Reserve Board’s final rule is an improvement from its initial proposal and recognizes many of the points we made in our case.”

It’s time for Plan B for the banking industry, following failure of Durbin delay

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Plan-b.jpgWith Congress voting down last week for the second time a delay in implementation of the Durbin amendment to Dodd-Frank, it’s time for the banking industry to move on.

Brian Gardner, an analyst with Keefe, Bruyette & Woods in Washington, D.C. wrote in a note to clients Thursday that Congressional action on the Durbin amendment is now “a dead issue.”

Karen Thomas, senior executive vice president for government relations and public policy at the Independent Community Bankers Association, said: “I think it’s going to have to rest for awhile.”

The Durbin amendment is estimated to wipe out $15.2 billion in annual debit card fee income by capping the fee banks can charge retailers for debit card transactions, according to R.K. Hammer Investment Bankers, a bank card advisory firm.

Although the regulation states only banks with more than $10 billion in assets will be impacted, many believe the impact will be felt even at much smaller banks, which Bank Director Editor Jack Milligan explained here.

Gardner expects the Fed to release its final rule on debit interchange fees within weeks (the rule takes effect July 21). Like other analysts, he expects the 12 basis point cap on fees to be the floor and that “the final rule will provide some relief to card issuers.”

Thomas said the Fed will have to consider the cost of fraud protection on debit cards, and she’s hopeful it will consider other costs as well.

So the focus has moved to influencing the final Fed rule, although at this late stage, that might be hard to do.

The bigger picture is that banks already have been making changes and will have a lot of work to do on their business models going forward: With slow economic growth, higher capital requirements and reduced fee income from products such as debit cards, how will some of them, especially the smaller banks, make money going forward?

Robert Hammer, chairman and CEO of R.K. Hammer in Los Angeles, argues that banks will now look for new sources of fee income.

“Fees will rise as an unintended consequence of the legislation, no matter how well intentioned the Durbin bill may have been,’’ he writes.

Among them, potential fees for customers who don’t use their debit cards very much. Already, banks have been scaling back rewards programs for debit card users.

But the fee issue is just one piece of the puzzle for banks that are looking now at the big picture of how to grow and make a profit in a slow economy.

Board members have become more engaged in these questions than in prior years, says Will Callender, a consultant for First Manhattan Consulting Group in New York.

“We are seeing more rigor around the strategic process,’’ he says. “In prior years, it was ‘we do (strategic planning) because we do this every year.’ Now, everybody is more involved and asking more questions. ‘What lines of business are critical? What’s our plan for growth or profitability?’”