U.S. Bancorp no longer plans to bide its time as competitors figure out how to recoup fee income regulated away by the Durbin amendment. Now it will be piling on with everyone else.
The Minneapolis company had been planning on sitting tight for several quarters to observe what worked and what didn't as other banks reacted first, a strategy that perhaps would have helped U.S. Bancorp gain market share from banks that upset their customers too much by implementing new fees or account requirements.
But the Federal Reserve's proposal last month to cap debit interchange fees at 12 cents per transaction forced the company to rethink its approach, Chairman and Chief Executive Richard K. Davis told analysts Wednesday on a conference call reviewing the fourth quarter.
"I said up until the last [quarterly earnings] call that we will be a laggard," Davis said. "I'm going to update that and tell you we're not going to be a late follower anymore, and [will] be right in the game."
The company, the fifth-largest U.S. bank by deposits, will start taking action by the middle of the year to offset the impact of the regulation, Davis said. Potential measures include changes to checking account pricing, reductions in debit awards and the charging of a debit card fee.
Davis said U.S. Bancorp also will "be working behind the scenes" to persuade the Fed to base its fee standard on a broader set of costs incurred by debit card issuers. Under the Fed's December proposal, summarized in a staff memo, issuers would be allowed to charge only enough interchange fees to cover the cost of authorizing, clearing and settling transactions. That equation leaves out the costs of debit card distribution, branches, relationship management, fraud coverage and other overhead.
The 12-cent cap is "so sufficiently and absolutely below the cost of doing business that we no longer have the luxury of waiting," Davis said.
His comments echoed those made Friday by Jamie Dimon, chairman and CEO of JPMorgan Chase & Co., who said the Durbin amendment was based in part on a "false premise" that "somehow, in a fixed-cost business, you can price to variable cost and survive."
Dimon estimated that the new rules would drive 5% of the industry's customer base into the ranks of the unbanked. He said the company wants to recoup some of the cost of the new regulations in a way that is "consumer-friendly and fair, but of course the consumer has got to pay, and they weren't paying for debit before."
With the stakes as high as they are, U.S. Bancorp is no longer interested in a wait-and-see approach. "I don't want to take that luxury because we now think that's taking risk," Davis said. He predicted that the industry essentially would move in lockstep, with no noticeable laggards among the biggest debit card issuers.
Chief Financial Officer Andrew Cecere said that without any mitigation measures, the company's annual debit and prepaid card revenue, which was $515 million in 2010, would be reduced 75% beginning in the second half of this year.
"The revenue would be below our cost for that product, which clearly is not a sustainable model," Cecere said in an interview with American Banker.
Debit is "a good product" for merchants that want to assure payment and for customers that want a convenient way to access their funds to make purchases, Cecere said, "and we want to offer it; we just have to create a pricing mechanism that makes sense."
Together with new overdraft fee policies, the Durbin amendment included in the Dodd-Frank Act is about to deliver the second half of a one-two punch for banks. U.S. Bancorp expects a $440 million to $480 million reduction in annual overdraft fees as a result of new regulations and voluntarily enacted overdraft reforms.
As different components of new overdraft regulations and policies got phased in over the last several quarters, the bottom-line effect gradually got larger. The full impact finally could be seen in the fourth quarter, when the annualized run rate for overdraft fees and other deposit service charges was less than half the $970 million collected in 2009, before any of the changes took hold.
Even with the reduced fee income, U.S. Bancorp was able to boost net income by 7.3% from the third quarter and by 62% from last year's fourth quarter, to $974 million, or 49 cents a share. The favorable comparisons were driven by record revenue of $4.7 billion, up 7.9% from the year-earlier quarter, and by declining credit costs, with the provision for loan losses falling for a fifth straight quarter.
New lending activity totaled $65.6 billion, the biggest quarterly increase in two years, as average total loans grew 1.5% from the third quarter. But utilization of wholesale credit lines declined by the same amount, bringing usage rates to a record low of 26.1%, versus 26.5% in the third quarter and 30% in the fourth quarter of 2009. Moreover, a record-high percentage of wholesale credit line customers are leaving their credit lines completely untouched.
"More customers are starting to establish lines of credit, but many of them are just not using it yet," Cecere said. "Almost half don't use it at all."
They're still paying for the privilege of having it, but the commitment fee that U.S. Bancorp collects is not as rich as what it would reap if the credit got tapped. That's something the company hopes to do more of when the economy improves.
"Establishing a line of credit," Cecere said, "is the first logical step to using it."