I discovered that my FCU automatically transfers funds from an LOC to cover overdrawn checking accounts even if the amount of the transfer will not fully cover the overdrawn amount. We charge a small fee for this service.

What frequently happens is the member/customer makes a monthly payment ($50/$100) and it gets advanced right back to the DDA within a few days. To me we shouldn't allow automatic advances from an LOC to a checking account less it would fully cover the overdraft. Or at least waive the $2.50 because they are also getting the overdraft fee. Thoughts?

Personally, I don't like the practice, but will need a convincing argument for my supervisors. Any ideas?

It all depends on how all of this is disclosed to the consumer. If an average consumer cannot figure out what will happened and what fees will be assessed, then you have a potential UDAAP. I do agree that advancing the LOC for an amount less than what the underlying account is overdrawn seems like a worthless transfer.