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The Overdraft Line of Credit (LOC) is pretty much a staple product for every bank, no matter what your asset size happens to be. While this product was originally designed to be sold only as a small personal line of credit, bankers quickly saw the opportunity to utilize it to cover DDA account overdrafts. Many customers love the protection from high fees and unpaid items that an overdraft LOC offers, but unfortunately for banks, this is one product has always underperformed from a profitability standpoint.
From a bank’s perspective, there are lots of negatives associated with overdraft lines. For one, if a customer has an overdraft LOC, the bank is potentially losing fee income that would be generated from NSF fees, not to mention that small unsecured lines of all types can be risky, period. But if you take that into consideration and price the product up, it still tends to struggle for profitability.
From a pure earnings stance, it really doesn’t make sense to offer the product. You are in a catch-22 situation here, though: if you decide not to offer overdraft LOCs, it could portray a negative image to customers, implying that either the bank doesn’t have a thorough suite of products … or that you are trying to “push” the customer into paying NSF fees. As a result, most bankers feel that the positives related to the customer experience far outweigh the negatives. Having the LOC product available helps to diffuse customer disdain for overdraft fees, and it also gives the customers who choose to use it peace of mind since they don’t have to worry about items being returned.
So, in a time where profitability in every area is an absolute must, how do banks get the most out of overdraft LOCs without having them become a drain on earnings? Here are a few best practices to consider:
- Increase the rate to the maximum allowed by applicable state law.
- Add a $5 transfer fee to each transfer to DDA account.
- Transfer exact dollars, not multiples of $100, to improve transfer fee collection.
- Charge a small processing / underwriting fee at origination (subject to applicable state laws).
- Charge an annual fee.
- Add a default rate to the product if the line becomes past due.
- Do not waive fees.
In addition, you can evaluate certain cost reduction methods to help improve the profitability of your overdraft lines. For example:
- Simplify underwriting by using a minimum acceptable beacon score cutoff, no exceptions. Base this score on experience with small unsecured lines of credit.
- Reduce document preparation time by developing an application / note document that contains proper disclosures (or send the disclosures post booking). Completion of this form at application results in full loan documentation if approved in underwriting and signed by the originating lender. Treat this account like any other credit card account.
- Do not establish a maturity date, avoiding a periodic renewal process. Use the collections process as a “review” opportunity.
- If possible, service this line of credit on the DDA system, allowing platform personnel to book the line. Monitor / control activity in Loan Operations and Collections.
By implementing these best practices and cost-saving measures, you can make the best of a traditionally unprofitable product while satisfying the needs of these specific customers.
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