I am concerned about a sentence found on our bank's information notice given to customer's at account opeing for our "Courtesy Pay" (overdraft program). The sentence reads, "If you receive a direct deposit for social security or other federal benefit, you must opt-out if you do not want us to apply these funds to repay an overdraft."
If the customer opts-out of the program, would the bank be prohibited from applying their direct deposit of a federal banefit to repay their overdraft?

Sounds like it to me.

Is there any law that prohibits the bank from applying a direct deposit of federal benefits to repay an overdraft?

No. But it has been very controversial.

http://www.bankersonline.com/infovault/courtwatch.html#millervboa

As Andy says, it's created some controversy and confusion, but primarily only in California due to decisions by the 9th Circuit. That's not to say it couldn't create the same confusion in other jurisdictions. If you're worried about it, I suggest you seek advice from outside counsel with experience in these matters.