How Will Durbin Amendment Impact Large Banks?

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As I have looked through bank financial statements the past few months, what has been striking is most money center and large regional banks have a revenue problem. Credit worthy loan customers have been hard to come by, domestic economic malaise and European economic uncertainty has cramped investment bank operations, and new federal regulations have conspired to create the revenue problem. I am going to look today at the Durbin Amendment to the Dodd Frank bill, which has cost banks billions. I am going also to look at some specific examples of how banks are coping with the new regulations.


Among the most substantive segment of the Dodd Frank Financial Reform Package was the Durbin Amendment, so named after its chief sponsor, Senator Richard Durbin of Illinois. The Amendment generally required rules to be passed that would ensure that any debit card interchange transaction fee must be “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” The Dodd Frank legislation itself states one of its many goals is to protect consumers, and the Durbin Amendment appears intended to do exactly that in the rules issued responsive to the mandate in the Durbin Amendment. The bottom line is that interchange fees that had averaged $0.44 per transaction would now be $0.24 per transaction.


The Durbin Amendment specifically exempted institutions with less than $10 billion in assets, though it is likely that market forces could well compel the smaller banks, thrifts and credit unions to lower their interchange fees as well. Intuitively though, the whole Durbin Amendment makes no sense. Its purpose stated in the language was to lower costs to small businesses, and thereby allow those businesses to lower prices to consumers and increase economic vitality.  Really, is $0.20 per purchase enough to accomplish any of those goals? I think not. The real impact, perhaps unintended, of the Durbin Amendment is to make credit card offers, awards, and rebates more attractive than ever. As such, more credit worthy, which usually refers to more affluent individuals, have been the beneficiaries. Other commentators foresee a “windfall” for retail concerns. In my opinion, small businesses are far more likely to pocket the interchange savings than to share it with customers.


What the rules did do is slash a $6.6 billion source of non interest revenue for the nation's largest banks. This comes on top of a cumulative annual $5.6 billion hit banks took when overdraft fees were limited. The timing of these revenue reductions could hardly have come at a worse time, as banks nearly uniformly struggling with revenue generation due to slackened loan demand and a flattened yield curve. The new lowered interchange fee went into effect October 1, 2011, so we have one full quarter to see how the Durbin Amendment has impacted some big banks. Some large card issuers, such as American Express (AXP), Capital One Financial (COF) and Discover Financial Services (DFS) were not impacted at all as they do not issue linked debit cards. For traditional banking institutions, the impact was apparent.


Bank of America's (NYSE: BAC) credit and debit interchange revenue fell from $1.494 billion in the third quarter of 2011, to $1.053 billion in the fourth quarter. As you all recall, Bank of America sought to at least in part replace the expected $1.6 billion reduction in annual debit interchange revenue by charging its customers a $5 monthly maintenance fee on its debit cards. Public outcry was so loud that Bank of America cancelled the fee prior to it ever really beginning. More recently, Bank of America has been ending its no fee checking programs. Other, more subtle ways to recover the non interest income will undoubtedly  come to pass, as Bank of America, whose overall non-interest income fell from $19.63 billion in the third quarter of 2011, to $14.91 billion in the fourth quarter. Debit interchange was not the only reason for this steep decline, but whether it is raising interest rates, eliminating free checking, raising trust fees, or any of an almost unlimited number of options, other fees must be raised to stem the decline in non interest income.


BBT's (NYSE: BBT) credit and debit interchange revenues fell from $208.4 million in the third quarter of 2011 to $63.2 million in the fourth quarter. For the year, BBT's non interest income fell 21% versus the 2010 total, due to a variety of factors in addition to the loss of fourth quarter interchange fees. BBT has been experiencing some loan growth, and maintained an above average net interest margin in the 4.0% to 4.1% range. That, in addition to a stellar 0.53 efficiency ratio, lower credit costs and a reduction in funding for loan loss reserves gave BBT a 58% boost in earnings in 2011 versus 2010. But like Bank of America, BBT has to find a way to turn around its non interest income. It is ending its free checking program, but more must be done.


JP Morgan Chase and Company's (NYSE: JPM) credit and debit interchange fees fell by $263 million on a sequential basis between the third and fourth quarters of 2011. JP Morgan has previously stated it expects to lose roughly $600 millon annually due to the Durbin Amendment. To combat the lost revenue, among JP Morgan's initiatives is it’s testing of a new, $5.00 fee for out of network automated teller machine (ATM) withdrawals. How long will that last?


Wells Fargo (NYSE: WFC) also took a hit from lost interchange revenue. The credit and debit interchange revenue fell from $948 in the third quarter of 2011 to $611 in the fourth quarter. Wells Fargo estimated the Durbin Amendment could cost it as much as $1 billion per year. In perhaps the most aggressive response to this loss of revenue, Wells Fargo is considering converting some of its over 6,000 retail branches into mortgage offices.


These are difficult days for banks. I look forward to first quarter earnings to see how margins have held up, and how banks are handling loss reserve funding. But I also will be looking at non-interest income trends. You should do the same.

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