Banks are starting to turn to prepaid debit cards as a response to the new Dodd-Frank legislation, and as a means to find new profits from their least profitable checking customers. This from a Reuters report released this Tuesday:

NEW YORK (Reuters) - JPMorgan Chase & Co (JPM.N) plans to move its least profitable checking customers into new accounts that rely more heavily on debit cards, in an effort to boost earnings in a business that has been clobbered by new regulations.

The accounts are known as "prepaid debt cards," and are like a checking account, except that customers cannot write checks and instead spend via a debit card.

A loophole in 2010's Dodd-Frank financial reform law allows banks to charge merchants relatively high fees for processing payments made with this type of debit card.

Chase will market the cards mainly to people who frequently overdraw their accounts, keep low balances, or do not qualify for a checking account at all.

The new service is being marketed as Chase Liquid at $4.95 per month, making it even less expensive than Chase’s student checking. And the fees cannot be waived, but the card must be linked to a JPMorgan Chase checking account. It’s one way banks are getting out of the “overdraft business” and finding new ways to generate fees and cut the cost of maintaining the account by eliminating paper processing. The debit cards also are deliberately linked to other Chase products to increase profits and reduce overall costs.

At this stage,this is an experiment, but other banks are following Chase’s example. Chase is still working to refine its new debit card strategy. Chase estimates that 10 percent of its current accounts don’t pay for incremental costs such as check processing. The strategy seems designed to find a way to minimize losses from less profitable customers so the banks can spend more time and resources attracting high net worth individuals.

Chase is trying the card out in 23 states through 5.500 branches, and the bank is not adding fees for deposits or withdrawals at its ATMs or branches. Although JPMorgan Chief Executive Jamie Dimon said this "could be a breakthrough product for consumers in terms of pricing transparency, convenience and simplicity," it’s clear that Chase is not betting the farm on prepaid debit cards. Dimon noted ”The management team doesn't want me to get too excited in case it doesn't work."

The industry is watching to see if this is the next trend in bank products.

Dr. Dan Geller, Executive Vice President of Market Rates Insight and head of our research and analytics department, contributed the attached article to BAI Banking Strategies this week.

Institutions that are not practicing regional pricing are very likely mispricing their deposits, even in a low-rate environment.

When it comes to deposit pricing, the U.S. market is far from homogenous. An analysis of the average deposit rates in the 50 states and District of Columbia during 2011 shows that the spectrum of change in rates among the states ranges from -35 to +9 basis points (bps) for a total range of 44 bps. Such a large range is a clear indication that deposit pricing should be regionalized to avoid over- or under-pricing.

There are numerous ways to look at rate changes, each providing a different perspective of the magnitude of change and the implications these changes might have on future pricing decisions. One way is to measure the absolute increase in the rates, which indicates the highest increases and decreases in basis points, but does not reflect the value of the change relative to the base rate. Another way is to measure the relative value of the increase or decrease, but not necessarily the highest or lowest increase in basis points. Finally, you can measure rate changes by reflecting the highest and lowest end value, i.e., identify the states with the highest and lowest average rate at the end of December 2011.

On one side of the deposit-rate spectrum is Massachusetts, which dropped 35 basis points, from 0.81% in January to 0.46% in December of 2011. At the other extreme, the average rate for deposits in Alaska increased by nine basis points during 2011, from 0.35% in January to 0.44% in December. The absolute spectrum of rate changes is therefore 44 bps.

Completing the list of the leading five states with the greatest drop in rates during 2011, behind Massachusetts, are: Ohio down 34 bps; District of Colombia, 32 bps; Connecticut, 31 bps; and Rhode Island, 30 bps. The five states that exhibited the smallest drop in deposit rates after Alaska are: Kentucky, with a drop of 8 basis points; Nebraska, down 9 bps; Utah, 13 bps; and Maine, 14 bps.

When measuring the relative change in deposit-rate value by state, the picture is slightly different. Topping the list of the highest declines in deposit-rate value is South Carolina, which lost over half the value of its deposit rate in 2011 – down 52% from 0.58% in January to 0.28% in December. On the other side of the spectrum is, again, Alaska, which increased the relative value of its deposit rate by 27% – from 0.35% in January to 0.44% in December.

The remaining states in the top five with the greatest loss of deposit-rate value after South Carolina are: Ohio, with a 51% drop; District of Colombia, with a 49% drop; West Virginia, down 48%; and Connecticut, 45%. Conversely, states in the top five with the least loss of deposit-rate value after Alaska are: Nebraska, down 14%; Kentucky, 15%; Iowa, 19%; and Arizona, 20%.

At year end 2011, the following states offered the highest average rate on deposits: Iowa, 0.80%; Louisiana, 0.62%; Florida, 0.60%; Wisconsin, 0.60%; and California, 0.59%. The five states with the lowest average rate on deposits were: South Carolina, 0.28%; West Virginia, 0.32%; Montana, 0.32%; District of Colombia, 0.32%; and Ohio, 0.33%. For reference, the national average rate for deposits at year end stood at 0.58%.

Bottom line, deposit rates are dynamic, even in a low-rate environment, especially when the rates are subject to regional factors such as demographics, unemployment and supply and demand. Therefore, those bankers who practice regional rate optimization have the advantage of greater pricing precision, which translates into lower cost of funds.

APY Spread Index
The APY spread is a simplified form of a standard deviation. It measures the variance between the high and low ends of the price range to the average, which indicates whether the APY of a particular CD is closer to the low or the high end of the pricing spectrum.

Premium Index
Premiums are used as the main vehicle to drive balances towards the most desired deposit products, and are an indication of the capital strategy of each individual institution. This week’s highest and lowest national premiums:

By Dr. Dan Geller, Executive Vice President

Every year, Dr. Dan Geller, Market Rates Insight’s chief analyst, provides a prediction of deposit trends for the coming year. We recently posted the second part of this year’s report. What follows is the third and final in a series of articles with this year’s forecast.

HOW LONG WILL “FREE INSURANCE” LAST ?

The announcement by the U.S. Federal Open Market Committee to keep the federal funds rate at a near zero level through mid-2013 supports the possibility that the mounting amount of cash accumulating in US bank deposits is eventually going to cause a cost reversal in interest on deposits because interest income from lending and interest expense from deposits are on a collision course. This means that loan rates
are going to decrease even further to stimulate lending, and deposit balances are going to increase due to economic and market uncertainty.

The first case of cost reversal in U.S. banking industry was amounted in August by the BNY Mellon, which is charging an interest rate of 0.13% on deposits of $50 million and over. However, the underlying reasons for the need to charge a premium for deposits is evident also on the retail side of banking and it won’t be long
before the threshold for “cost reversal” will go down to lower level of account balances.

This transformation is not by design and was not concocted in the boardroom of any bank; rather it was created by market forces responding to economic circumstances. The phenomenon of cost reversal
became evident during the last recession and has intensified ever since, as we warned last October.
Here are some of the factors that are creating the need for cost reversal on the consumer side and the banking side. First, the last U.S. recession and its lingering “recovery” created economic uncertainty among consumers and businesses. Naturally, in times of economic uncertainty, the normal reaction is to seek safety and security of the capital at hand rather than focus on potential returns.

This is exactly what happened with insured bank deposits during and since the last recession. Domestic deposits increased by over a trillion dollars since the official start of the recession in December of 2007 despite the fact that the average interest rate paid on these deposits decreased from 3.82% to 0.82% – a decrease of 300 basis points.

Second, the purpose of capital, mainly in the form of consumer deposits, is to lend. Yet with the soft lending market, the excess deposit capital is becoming very costly because it keeps on generating interest expenses and FDIC insurance expense regardless of the demand for loans. As long as the Net Interest Margin (NIM) can be profitably maintained, banks can sustain the excess expense.

However, at some point, when deposits continue to grow and the lending market remains soft, the burden of the excess expense will pull the NIM to an unprofitable level. Based on the latest FDIC data, the trend is headed in that direction. In the first quarter of 2011, interest income stood at 3.88% of assists compared to
4.20% a year earlier.

At the same time, interest expense in the first quarter of 2011 stood at 0.70% compared to 0.88% as a result of decreasing interest rates on deposits. If interest income will continue to decrease due to soft lending market, interest expense will have to be reduced even further; and with interest rates already exceptionally low, the only way to achieve that is with negative interest rates, which de facto is a cost reversal from the banks to the consumer.

Are U.S. consumers going to “accept” the new reality of paying for the safety and security of their deposits? Chances are they will – not because they want to but due to a lack of alternatives. Most other investment options, such as mutual funds, stocks, bonds and commodities, involve risk to the principle. So the question facing the public becomes: how much is it worth knowing that your principal is safe no matter what? So far the answer is 13 basis points, which is the interest rate the Bank of New York Mellon is charging.

SHRINKING RATE VARIANCE BETWEEN INTERNET & BRANCHES

Deposit-rate variance between Internet banks and brick and mortar banks (aka Branch banks) is shrinking. However, the shrinkage is not uniform across all deposit products, which indicates that there is a difference between the liquidity strategy and risk of Internet vs. Branch banks.

As of December 1st 2011, the national average APY for term accounts of Internet banks is only 4 bps higher than that of Branch banks. The highest variance is in 12-month CD, 16 bps, and the lowest variance is in 5-year CD, where the variance is negative 24 bps (Figure 5).

The national average APY variance of liquid accounts is currently 41 bps, with MM commanding the highest variance at 71 bps, and checking the lowest with 10 bps (Figure 5).

In the last five years, the national average APY variance on term accounts dropped by 20 bps - from 0.24% to 0.04%. For liquid accounts, the national average APY variance dropped from 0.91% to 0.41% (Figures 5 & 6).

Implications:

• Internet banks are more price aggressive in liquid accounts, while branch banks are closing the APY gap of term accounts.
• Internet banks are more price aggressive in short-term CDs, while branch banks are more price aggressive in longer-term CDs.
• Internet banks are becoming more rate aggressive with checking accounts, which was not the case five years ago.

HOW TO PREPARE FOR UNCERTIANTY IN 2012

The only way to combat uncertainty is to be prepared and to increase focus in two main areas:

• Greater control over your interest expense
• Better management of your deposit balances

Control your interest expense:

Higher interest expense is caused primarily by product mispricing due to inability to identify various types of CDs (beyond term and tier) when establishing a rate. Mispricing occurs when a rate is established based on competitive information without the corresponding type of CD next to the APY. The APY variance between regular CD and other CD types, such as callable CD, can be as much as 39 bps. Thus, if a rate is set not knowing the type of the competing CD, an over pricing of up to 39 bps can occur.

Figure 7 is an analysis of APY differences between various types and regular CD.

Manage your deposit balances

Your deposit balances are impacted more by the APY variance between you and your market average than your APY alone. This means that your APY variance controls most of your balance changes. Nationally, 55% of the changes in balances derive from changes in the APY variance (varies by market). Thus, your balances
may change even if you do not change your rates. For example, the APY variance of MM up to $10K impacts 84% of the changes in the balance of this product. You will be able to conduct variance analysis for each of your product and markets and anticipate impact on balance.

Figure 8 is an analysis of the impact of APY variance on balances of different products.

By Dr. Dan Geller, Executive Vice President

Every year, Dr. Dan Geller, Market Rates Insight’s chief analyst, provides a prediction of deposit trends for the coming year. Attached is the first in a series of articles with this year’s forecast.

Expect 2012 to be a gray swan year; a year in which we know a risk is plausible, but we don’t know how it will impact the financial and banking industries. Unlike a black swan, which is a highly improbable and unknown risk, the gray swan of the banking industry is the financial faith of the European Union, which is made up of 27 member countries, especially the 17-member Eurozone countries. Although the U.S. exposure to the EU from a trade balance is only about $140 billion, the real risk is with the banking industry.

Continued turmoil in the Eurozone in 2012 is very likely to impact the financial and banking markets in the U.S. because of the interdependence of the global banking system and its reliance on the LIBOR (London Interbank Offered Rate), the world’s most widely used benchmark for short-term interest rates. LIBOR is the rate at which the world’s banks borrow money and is fixed on a daily basis by the British Bankers’ Association based on an average of interbank deposit rates for larger loans at the world’s most creditworthy banks.

One possibility is that money supply in the EU will tighten, causing the LIBOR to go up due to limited money supply. Higher LIBOR is very likely to impact borrowing interest rates in the US. because when banks borrow at a higher rate, they pass the increase in their borrowing cost to the consumer.

Another option is that LIBOR will decrease as a result of over liquidity due to increased money supply in order to stimulate the EU economy. Such a scenario is likely to put even greater pressure on net interest margins, causing deposit rates in the U.S. to go all the way to near zero.

Current indications are that the LIBOR is trending up as a result of the economic and financial status of the EU. The average LIBOR rate, which consists of the average of the 1, 3, 6 and 12 months rates, rose to 0.60% this November compared to 0.43% in April of this year - an increase of 40% in seven months. Historically, LIBOR rates and U.S. deposit rates have been highly correlated, which is the result of the inner dependability of the global financial world.

The instability of the EU financial system is a result of two main factors, one systematic and one cyclical. The systematic factor is the European sovereign debt crisis, which was caused by runaway government spending in some European countries. For example, Greece, Portugal and Italy all have elevated debt-to-GDP ratios, which when coupled with the second factor, the burst of the housing bubble in Europe, made it even harder for these countries to grow their economies.

Economic growth is a must in order to reduce and stabilize debt-to-GDP ratios, especially for countries like Italy, which has nearly €2 trillion in outstanding government debt. Moreover, Italy has slim growth prospects in the near term because it first needs to reform its labor market in order to increase productivity and become more competitive. Similarly, yet less drastic is the situation that exists in Spain, Greece, Portugal and Ireland.

Since “organic” economic growth is not very likely in the short term for these members of the EU, the only two options left are default on their government-issued bonds, or to receive financial assistance from the ECB (European Central Bank), to support the Italian government bond market until stronger economic growth begins to take place. Just to put things in prospective, Italy is the 8th largest economy in the world measured by GDP.

In addition to, or because of, the uncertainty caused by the financial events in the EU, we have another unknown in 2012 – the direction of deposits APY and balance. Yes, generally speaking, APY has been on the decline in the past four years, and deposit balances on the rise. But a look at the rate of increase and decrease indicates that the year-over-year variance has wide fluctuations, which makes yearly projections somewhat challenging.

For example, the decrease in APY in 2011 was 36% less than in 2010, and conversely, the balance increase in 2011 was 300% greater than in 2010. Hence, it’s not just that we don’t know which way balances and APY are headed in 2012 due to the uncertainty of the financial crisis in the EU, we don’t even know the extent of the change once it occurs.

The best advice I have to offer is borrowed from Nassim Nicholas Taleb, the author of the Black Swan - when you can’t predict; be prepared. In other words, at this point we don’t know if the financial crisis in the EU will trigger a rate hike or push rates farther down. But, we can be prepared for both scenarios. The best
way to be prepared is to keep a close eye on deposit rates, and to develop two pricing scenarios; one for rate increase, and the other for rate decrease.

Consumers are mad as hell and they aren’t going to take it any more. Consider recent news stories about Bank of America reversing itself on plans to impose a $5 monthly swipe fee for ATM card users. According to news reports, the change in strategy was the direct result of customer feedback:

"We have listened to our customers very closely over the last few weeks and recognize their concern with our proposed debit usage fee," Bank of America co-COO David Darnell said in a written statement. "Our customers' voices are most important to us. As a result, we are not currently charging the fee and will not be moving forward with any additional plans to do so."

And consider the pending impact of tomorrow’s Bank Transfer Day, where thousands of unhappy depositors are expected to migrate their money. This movement is seen to be closely allied to the sentiment driving the Occupy Wall Street movement, and is an attempt by consumers to make their concerns known in the banking community.

Much of this pressure is the direct result of the recently enacted Dodd-Frank financial reform act, which limits the amount of fees banks can charge retailers for ATM purchases. But will banks continue to knuckle under to consumer pressure? According to a story posted by the New Republic, the exodus of protesting depositors could be a blessing in disguise:

"At the root of the problem is that many Bank Transfer Day enthusiasts have overestimated their value to the banks they patronize: Ultimately, not all bank customers are made equal. Most customers of banks aren’t wealthy (we know from the Federal Deposit Insurance Corporation that 57 percent of all deposits at big banks are under $250,000), but it’s the wealthy upon whom the business models of big banks mostly depend. According to Jennifer Tescher, President and CEO of the consultancy Center for Financial Services Information, banks typically earn at about 80 percent of their deposit revenue from the top 20 percent of their customers.”

The passage of Dodd-Frank has converted the majority of low-balance depositors into a clear liability for big banks. Experts estimate that a customer now has to maintain an average balance of $25,000 in order to be profitable for banks, especially when you consider the overhead from processing transactions, staffing, and the like. And the banks are still suffering from the hangover of loan binging before 2008, when any depositor with a checking account could qualify to borrow money. Now the limits on levies for overdraft fees and “swipe fees” make these depositors much less desirable because they are no longer profitable.

In many ways, Bank Transfer Day and the backlash against big banks is going to help institutions like Bank of America by helping drive the dead wood out of the deposits. By interpreting these new fees as greed, consumer think they are punishing big banks by taking their trade elsewhere, when in reality they are helping banks support more profitable accounts.

Each month, Market Rates Insight offers a projection of national APY performance for the coming month.  During this month, the national average APY for Regular term accounts is projected to decrease 1 bps to an APY of 0.60%. The national average APY for Special term accounts is projected to decrease 2 bps to an APY of
0.94% (Figure 1).

Among Regular term accounts, there will be a slight decrease of 1 bps in the 3, 6, 12, 48 and 60-month CDs to the an APY of 0.13%, 0.21%, 0.33%, 0.99% and 1.24% respectively. Among the Special term accounts, the 3 and 6-month CDs are projected to decrease 3 bps each to an APY of 0.32% and 0.52% respectively. The 24 and 60-month CDs are expected to decrease by 2 bps each to an APY of 0.85% and 1.29% respectively.

Liquid Accounts Projection

The national average APY for Regular liquid accounts is projected to remain flat at 0.14%. The national average APY for Special liquid accounts is projected to increase 1 bps to an APY of 0.47% (Figure 2).

Regular checking account APY is projected to remain flat at 0.11%; whereas savings and MM will decrease 1 bps each to and APY of 0.15% each. Among the Special liquid accounts, checking is no longer offered, and savings is projected to remain flat at 0.65% and MM Special is projected to increase by 2 bpt to an APY of 0.29%.

Note: The monthly APY projection for deposit accounts is based on national averages and has a confidence
level of 95%. Identical projection for individual pricing regions (states) may be ordered. This
projection accounts for customary fluctuation in economic indicators such as Fed funds rate, inflation
and others. However, the projection may have to be revised if a drastic change occurs in some of the
economic indicators during the projected month.

Well the numbers are in, and it looks like profits are up for the big banks, or at least for Citigroup and Wells Fargo.

According to a report in yesterday’s Silicon Valley/San Jose Business Journal, Citigroup posted a 74 percent increase in profit, up $3.8 billion ($1.23 per share) in three-quarter revenue. The majority of that profit seems to be coming from “a paper gain of about $2 billion and $1.4 billion from reserves set aside to cover future loan losses.” This despite the fact that revenue remained flat at $20.8 billion and despite a weak performance from the investment banker group. This from Vikram Pandit, Citi’s Chief Executive Officer talking about yesterday’s earnings news:

“We continued to manage our risk prudently while growing the businesses that are core to our strategy. We have reduced the size of Citi Holdings to 15% of our balance sheet and further improved our financial strength. We are very well positioned as we help our clients navigate the world's current trends and key opportunities.

"In addition, over the past few years we have significantly strengthened our retail partner cards business and it has earned $2.2 billion pre-tax through the first three quarters. After a careful review of the business, which took into account current trends in credit and technology, we have decided that it makes strategic sense to move retail partner cards and a vast majority of its assets from Citi Holdings into Citicorp. The transition will be completed by the end of this year."]

As reported in the Dallas Business Journal yesterday, Wells Fargo reported a 21 percent earnings jump in the third quarter. Wells Fargo posted a net income of $4.1 billion ($0.72 per share) compared to $3.3 a year earlier. This despite the fact that revenue was down for the quarter, falling to $19.6 billion from $20.4 billion a year ago. The bank is crediting strong loans and an increase in deposit growth for the increase in earnings:

“The economic recovery has been more sluggish and uneven than anyone anticipated,” Wells Fargo's chairman and CEO, John Stumpf, said in a statement. “We can’t change the economic environment, yet we have worked hard to control the variables we can – making our products and services more relevant to individuals and businesses, focusing on the customer, making as many loans as possible and growing new relationships – as well as fostering longtime ones."

If these reports from two of the major trends spark a trend, then banks are going to increasingly rely on fees and deposit growth to spur earnings.

American Banker and Market Rates Insight feature a weekly APY Spread and Premium indices to provide pricing executives with greater insight into national pricing trends and practices:

APY Spread Index
The APY spread is a simplified form of a standard deviation. It measures the variance
between the high and low ends of the price range to the average, which indicates whether
the APY of a particular CD is closer to the low or the high end of the pricing spectrum:

Premium Index
Premiums are used as the main vehicle to drive balances towards the most desired deposit
products, and are an indication of the capital strategy of each individual institution. This
week’s highest and lowest national premiums:

There has been a lot of controversy in recent weeks with Bank of America’s announcement that they are imposing a $5 monthly fee on ATM transactions. Senator Richard Durbin’s response was to tell depositors to bank elsewhere, which led BofA CEO Brian Moynihan to remind the market that they are in business to make money and they should be allowed to earn a profit. This from the CNNMoney:

Bank of America's CEO defended his bank's new $5 fee on debit cards on Wednesday, saying that customers and shareholders understand the bank has a "right to make a profit."…

Moynihan stopped short of criticizing President Obama who earlier this week said to ABC that banks don't have an "inherent right" to a "certain amount of profit."

But BofA's chief did say banks have an inherent right to make a profit in an interview Wednesday with CNBC's Larry Kudlow at the Washington Ideas Forum, sponsored by the Newseum, the Aspen Institute and the Atlantic magazine.

"I have an inherent duty as a CEO of a publicly owned company to get a return for my shareholders," Moynihan said.

So how are the fees stacking up now to help banks build profits? Here’s the latest roundup from ABC News on checking fees for the 10 largest banks:

Bank of America

• Checking: $25 deposit to open; $8.95 monthly fee unless statements are paperless and deposits/withdrawals are done online or by ATM.
• Debit Card: Included with all checking accounts (no additional fees); $5 debit fee to be rolled out in early 2012, which can be waived under certain circumstances.

2. Wells Fargo

• Checking: $100 deposit to open; $5 monthly fee unless direct deposit or average balance of $1,500.
• Debit Card: Included with all checking accounts (no additional fees); test marketing $3 debit fee in five Western states, possible national rollout.

3. JPMorgan Chase

• Checking: $25 deposit to open; $12 monthly fee unless direct deposit of at least $500, minimum balance of $1,500 or $5,000 average daily balance in linked accounts.
• Debit Card: Included with all checking accounts (no additional fees); test marketing $3 debit fee in Georgia and Wisconsin, possible national rollout.

4. Citigroup

• Checking: $0 to open; $8 monthly fee, waived if account has two of the following: direct deposit, online bill payments, ATM withdrawal, debit card purchase.
• Debit Card: Included with all checking accounts (no additional fees).

5. US Bank

• Checking: $50 to open; $6.95 monthly fee with online statements or $8.95 with paper statements unless direct deposits of at least $500 or average account balance of $1,500.
• Debit Card: Included with all checking accounts (no additional fees).

6. PNC

• Checking: $25 to open; no monthly fee.
• Debit Card: Included with all checking accounts (no additional fees).

7. TD Bank

• Checking: $0 to open; $2.99 monthly fee with online statements or $3.99 monthly fee with paper statements.
• Debit Card: Included with all checking accounts (no additional fees).

8. Capital One

• Checking: $50 to open; $8.95 monthly fee unless $300 minimum daily balance or monthly direct deposit of at least $250.
• Debit Card: Included with all checking accounts (no additional fees).

9. SunTrust

• Checking: $100 to open; $7 monthly fee unless minimum balance of $500 or direct deposit.
• Debit Card: $5 monthly fee for unlimited debit card usage.

10. BB&T

• Checking: $50 to open; $10 monthly fee unless direct deposit, $1,500 average balance or a mortgage with BB&T.
• Debit Card: Included with all checking accounts (no additional fees).

Market Rates Insights tracks bank fees and new banking products as part of our research for banks and credit unions. If you need to get a better understanding of the competitive forces affecting bank products in your market, we can help.