CUNA Regulatory Comment Call

March 11, 2010

Fed Requests Comments on Third Set of Regulation Z Rules Implementing the New Credit Card Law

Executive Summary

Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Senior Vice President and Deputy General Counsel Mary Dunn at mdunn@cuna.com or Senior Assistant General Counsel Jeff Bloch at jbloch@cuna.com; or mail them to Mary and Jeff in c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, 6th Floor, Washington, DC 20004. You may also contact us if you would like a copy of the proposed rules or you may access them here.

BACKGROUND

In January 2009, the Fed issued final rules that included comprehensive changes to the open-end credit rules under Regulation Z, as well as the official staff commentary, which primarily affected credit cards and other revolving credit plans. These included comprehensive changes to the format, timing, and content requirements for the credit card application and solicitation disclosures, account-opening disclosures, periodic statements, change-in-term notices, and advertising provisions. At the same time, the National Credit Union Administration, the Fed, and the other federal financial institution regulators issued final rules under the Unfair and Deceptive Acts and Practices (UDAP) Act that prohibit or restrict a number of credit card practices.

In May 2009, the CARD Act was enacted that amended the Truth in Lending Act (TILA) to include many of the acts or practices that were included in the UDAP rules issued in January 2009 and this also included provisions of the Regulation Z rules that were issued at that time. The CARD Act also included additional restrictions and disclosure requirements that were not included in the rules issued in January 2009. The UDAP rules were later rescinded as they were duplicative of many of the CARD Act provisions.

The Fed has now issued the third in a series of rules to implement the CARD Act. These proposed rules implement the provisions that will be effective on August 22, 2010. The Fed had earlier issued rules to implement the provisions that became effective on August 20, 2009, as well as those provisions that were effective on February 22, 2010. Click below for more information about these earlier rules:

http://www.cuna.org/reg_advocacy/member/download/fed_012910.pdf

http://www.cuna.org/reg_advocacy/reg_call/rcc_073009.html

DESCRIPTION OF THE PROPOSED RULES AND PROPOSED CHANGES TO THE OFFICIAL STAFF COMMENTARY

I. Requirements to Impose Reasonable and Proportional Penalty Fees

The CARD Act requires that penalty fees and charges imposed on credit card accounts be reasonable and proportional to the violation. This proposal would generally define such a fee as one based on an act or omission of the consumer that violates the terms of the account or other requirements imposed by the card issuer with regard to the account, other than charges attributable to changes in interest rates. These would include late payment fees, returned payment fees, and over-the-limit fees.

The proposal would not cover certain other fees. These include balance transfer fees, cash advance fees, foreign transaction fees, annual fees, fees for credit insurance, expedited payment fees, fees for optional services, or fees for reissuing a lost or stolen card. The proposal outlines the following three alternatives for determining the amount of the penalty fees.

Alternative One – Fees Based on Costs

Under the proposed rules, the penalty fee for a specific violation must represent a reasonable proportion of the costs incurred by the issuer as a result of the specific type of violation. This would not require that the fee be reasonable and proportional to the costs incurred as a result of a specific violation on a specific account. Here are the factors that would be relevant to making this determination:

The card issuer, at its option, may base the fees on a reasonable estimate of changes in the number of violations of that type and the resulting costs during an upcoming period. In the example described above, for instance, the late payment fee could be $25 if the costs are expected to increase to $25 million.

However, higher rates of losses and other related costs, such as the cost of holding reserves against these losses, must be excluded from this calculation.

The following outlines the costs that may be considered for purposes of determining late payment fees, returned payment fees, and over-the-limit fees:

Amounts charged to card issuers by third parties as a result of violations of account terms may be considered costs incurred by the card issuer for purposes of calculating the penalty fees. However, if the amount charged is from an affiliate or subsidiary of the card issuer, such as a CUSO, then the issuer must determine that this amount represents a reasonable proportion of the costs incurred by the affiliate or subsidiary.

Alternative Two – Fees Based on Deterrence

Under this alternative, the card issuer may charge a fee in an amount that is reasonably necessary to deter the specific type of violation. This would not require that the fees be necessary or calibrated to deter individual consumers from engaging in specific violations.

For this alternative, the issuer must use an empirically derived and statistically sound model that reasonably estimates the effect of the fee on the frequency of violations. This model must also demonstrate that a lower fee, which must be above $0, would result in more violations. This would require issuers to test fees that are both above and below the actual fee.

For both the alternatives described above, the fees would have to be re-evaluated at least on an annual basis. If the re-evaluation results in a lower fee, then the new fee must be in effect within thirty days after the review. If this results in a higher fee, then the issuer must comply with the Regulation Z change- in-terms provisions.

Alternative Three – “Safe Harbor” Fees

The third alternative would be a specific fee as set by the regulation for each violation that would be considered compliant with these provisions, otherwise known as a “safe harbor” fee. The proposal does not now include these specific fees, but the Fed requests input on what the amount should be for these fees. Once they are determined, these fees will be adjusted for inflation, and the Fed will publish the adjusted fees. These fees will be increased or decreased by increments of $1, based on the cumulative inflation rate that occurred since the prior adjustment.

Under this alternative, a penalty fee could exceed the specific safe harbor amount in certain circumstances. Specifically, an issuer may impose a fee that does not exceed 5% of the dollar amount associated with the violation, up to a specific dollar amount, which is also not currently specified. For example, a late payment fee of $25 could be charged if the minimum payment amount was $500, even if the fee exceeds the safe harbor amount.

Additional Information Applicable to All Alternatives

Regardless of the alternative chosen by the card issuer, the proposed rules would prohibit the following:

In general, fees may be rounded to the nearest whole dollar, and the proposal would clarify that assessing fees that are comparable to other card issuers would not be sufficient to comply with the proposed rules. The proposal would also amend the model forms to reflect these new changes. The application, solicitation, and account-opening disclosures would use bold type for the maximum fee limits and would be expressed as “up to $XX.” The model forms for periodic statements would be changed to require language to indicate a late payment fee may be lower than the disclosed amount. A range of late payment fees may also be disclosed. Corresponding changes would be made to the model language for change-in-terms notices for late payment fees and to the model forms that are used to obtain a consumer’s consent to the issuer’s payment of over-the-limit transactions. Click below for a copy of these amended model forms, which follows the text of the proposed rules.

II. Re-evaluation of Interest Rate Increases

Consistent with the CARD Act, the proposed rules would require card issuers to review an increase in the annual percentage rate (APR) no less frequently than once every six months until the time the rate is reduced to what it was before the increase or, for variable rates, until the time the index and margin is the same as that applied before the rate was increased. This would only apply to rate increases that require a 45-day notice under other provisions of Regulation Z, which means the proposed rules would not apply to rate increases based on changes in variable rates, expiration of properly disclosed introductory or promotional rates, or other situations that do not require such notice. These provisions would also only apply if an increased rate is actually imposed on the account.

These provisions would apply to increases based on the credit risk or creditworthiness of the consumer, market conditions, cost of funds, or other factors and applies to all such increases that have occurred since January 1, 2009. Card issuers must have reasonable, written policies and procedures for conducting these reviews. For rate increases imposed between January 1, 2009 and August 21, 2010, the first review must be conducted before February 22, 2011, which will be six months after the effective date of these provisions. In general, card issuers may review all their accounts at the same time every six months, review each account once every six months on a rolling basis based on the date in which the rate was increased for that account, or use another process to ensure compliance with the six-month timeframe.

The card issuer may either review the same factors on which the rate increase was originally based or review the factors that the card issuer currently considers when determining the APR for its credit card accounts. If the card issuer changes these factors from time to time, the issuer may for a brief transition time after each change use either the factors it considered immediately prior to the change or it may consider the new factors.

However, if the issuer uses different factors based on the type of account, then the issuer must use the factors that apply to the specific account. For example, an issuer may use different factors if the account has an annual fee or rewards. If the consumer does not have an annual fee, then the issuer must use the specific factors that it uses for all such accounts that do not have annual fees.

Card issuers must reduce the APR based on this review, if appropriate, and the rate must be reduced within thirty days after the evaluation. However, the rate would not necessarily have to be reduced to what it was prior to the increase, as long as the decrease is determined pursuant to the required policies and procedures. Also, these provisions would not require a change in the rate structure. For example, if a creditor is currently use the London Interbank Offered Rate (LIBOR) index but is reviewing rates that use the prime rate, the creditor can continue to use the prime rate when making any downward adjustments, as long as any adjustments are comparable to what they would have been if the creditor used the LIBOR index.

When providing the 45-day notice of a rate increase, the CARD Act requires the card issuer to disclose the reasons for the increase. To implement this provision, the proposed rules would require that no more than four reasons be disclosed, listed in the order of importance. There would be no minimum number of reasons that would have to be disclosed, so only one reason could be provided. This will also be the case if the rate increase is due to a delinquency, default, or as a penalty that is not due to a change in the contractual terms of the account.

The reasons provided must relate to and accurately describe the factors that were actually considered by the card issuer. However, they could be described in general terms, such as due to a “decline in your creditworthiness” or “decline in your credit score,” as opposed to indicating the specific number of points in which the credit score declined. Similarly, the reason could be “a change in market conditions” if the issue is a specific increase in the issuer’s cost of funds. In certain circumstances, the creditor may combine reasons in one statement, such as indicating that the rate increased both because of a late payment and the resulting decrease in the credit score. The proposed rules would also amend the applicable model forms and sample clauses to incorporate examples of the disclosure of the reasons for a rate increase.

Under other provisions of Regulation Z, the card issuer may increase rates if the minimum payment is not received within 60 days after the due date. Under these provisions, the card issuer must reduce the APR to the rate that applied before the increase if the consumer then makes six consecutive minimum payments. In these situations, the card issuer would not be required to review these rate increases under the provisions of this proposal unless the rate was not decreased based on the consumer making these six consecutive payments. If the rate is not decreased after this time period, then the review process under this proposal would apply to the subsequent six-month periods.

The obligation to re-evaluate increased rates would apply even to accounts acquired from other issuers. The acquirer may either use the factors that the original issuer considered or may use the factors it currently considers in determining APRs for its other credit card accounts. The proposal provides an alternative means to comply in these situations. Under this alternative, the acquirer may choose to review all of the acquired accounts as soon as reasonably practicable after they are acquired and would then have to conduct the periodic review required under this proposal for only those accounts in which the acquirer increased the rate as a result of this initial review.

However, the acquirer would have to conduct the periodic review required under this proposal for any acquired account that is the subject of a penalty rate or a rate that is due to the consumer’s delinquency or default. Also, if the acquirer raises a rate as a result of the initial review, it must comply with the other Regulation Z disclosure and substantive requirements as they apply to changes in rates.

The proposal provides the following two exceptions to the requirement to re-evaluate interest rate increases:

QUESTIONS TO CONSIDER REGARDING THE REGULATION Z PROPOSED RULES
(The Fed has specifically requested comment on these issues)

  • Which one or more of the Fed’s alternatives for determining penalty fees do you feel should be included in the final rule?
















  • Are there additional methods for regulating and determining the amount of penalty fees based on the consumer’s conduct? For example, for the safe harbor penalty fees that will be determined later, should there by tiers in which a higher fee could be assessed for subsequent violations, such as a higher late payment fee for a second late payment during a single 12-month period? Should fees be imposed in increments, such as a fee of $5 for every day that a payment is late?
















  • For determining penalty fees based on costs, the proposal would not allow for consideration of higher rates of losses and other related costs as part of this calculation. Do you agree or should these factors be permitted as part of this calculation?
















  • For determining penalty fees based on costs, the proposal outlines the specific costs that may be considered for late payment fees, returned payment fees, and over-the-limit fees. Are there other costs that should be considered for these types of fees?
















  • For the alternatives of calculating fees based on costs and fees based on deterrence, these determinations must be reviewed on an annual basis. Is an annual basis an appropriate interval for making these determinations? Do you have any comments on how this testing should be done, such as the representative sample and the period of time that is used?
















  • What would be the compliance burden of the proposed requirement of limiting an individual fee to no more than the dollar amount associated with the violation, such as charging a late fee that is no more than the minimum payment? Specifically, what would be the burden of making these mathematical determinations and implementing the programming systems to make these calculations automatically? What additional guidance is necessary with regard to this proposed limitation?
















  • The proposal would prohibit fees for transactions that the issuer declines to authorize, primarily because there is no dollar amount associated with a declined transaction and because the costs are relatively low. In addition, the proposal would prohibit inactivity fees or fees associated with the closure or termination of an account because these are also not associated with dollar amounts. Do you agree that these fees should be prohibited?
















  • The Fed has not at this time determined the “safe harbor” fees. Do you have suggestions on what these fees should be and do you have information or data to support these amounts? Do you have information as to the dollar amount of fees that would be necessary to deter violations and what were the methods used for making these determinations?
















  • Under the “safe harbor” alternative, a penalty fee could exceed the specific safe harbor amount in certain circumstances. Specifically, an issuer may impose a fee that does not exceed 5% of the dollar amount associated with the violation, up to a specific dollar amount that is also not currently specified. What should this dollar limit be? Is 5% an appropriate percentage? Do you have any other comments with regard to the “safe harbor” alternative?
















  • How do you manage risks with charge cards and should this proposal be adjusted for charge cards in order to manage these risks?
















  • Under the proposal, if a rate is reduced as a result of a six-month review, the rate must be reduced within thirty days after the review. What are the operational issues with regard to lowering the rate? Should there be a different timeframe instead of thirty days?
















  • What transition guidance may be needed for reviewing rates that were increased between January 1, 2009 and August 22, 2010, which will be the effective date of the proposed rules?
















  • Card issuers must have reasonable, written policies and procedures for conducting these six-month reviews. Is more guidance needed on what is considered “reasonable?”
















  • For the six-month reviews, the card issuer may either review the same factors on which the rate increase was originally based or review the factors that the card issuer currently considers when determining the APR for its credit card accounts. If the card issuer changes these factors from time to time, the issuer may for a brief transition time after each change use either the factors it considered immediately prior to the change or it may consider the new factors. Should the proposal define what is considered a “brief transition time,” such as thirty or sixty days?
















  • The proposal would require review of rate increases every six months, unless the rate is reduced to what it was before the increase. Should this obligation to review increases every six months end at a certain time period after the rate is initially increased, such as five years, regardless of whether the rate is ever decreased?
















  • The obligation to re-evaluate increased rates every six months applies to accounts acquired from other issuers. In order to comply, the acquirer may choose to review all of the acquired accounts as soon as reasonably practicable after they are acquired and would then have to conduct the review required under this proposal for only those accounts in which the acquirer increased the rate as a result of this initial review. Do you agree with these provisions? Are there alternatives that better balance the burden on card issuers with the benefit to consumers? What additional guidance is needed with regard to the term “as soon as reasonably practicable?”
















  • Do you have any comments on the amended model forms?
















  • Other comments?
















    Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
    Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 • mdunn@cuna.com
    Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
    Luke Martone • Senior Regulatory Counsel • (202) 508-6743 • lmartone@cuna.com