On March 15, 2010, the Federal Reserve Board a published proposed rule to implement the final phase of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act), which is effective August 22, 2010. The proposed rule requires that penalty fees imposed by card issuers be reasonable and proportional to the violation of the account terms. The rule also requires credit card issuers to reevaluate increases in APRs at least every six months, for APRs increased on or after January 1, 2009.
I. Reasonable and Proportional Penalty Fees
General Rule on Penalty Fees: The Board proposes that penalty fees charged to consumers be reasonable and proportional to the violation for which they are imposed. The rule applies to fees such as late fees, returned-payment fees, and over-the-limit fees, but not to rate increases.
The proposal prohibits creditors from imposing a fee for violating the terms of an account unless the fee is based on either (a) a reasonable proportion of the total costs incurred by the issuer for that type of violation or (b) the amount reasonably necessary to deter that type of violation using an empirically derived, demonstrably and statistically sound model that reasonably estimates the effect of the amount of the fee on the frequency of violations. The Commentary to the proposal makes clear that the fact that a card issuer’s fees for violating the account terms are comparable to fees assessed by other issuers does not satisfy the requirements of the rule.
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Fees Based on Cost – If basing the fee on cost, the issuer must have determined that the fee for violating the terms of the account represents a reasonable proportion of the costs incurred by the issuer for that type of violation. The factors relevant to the determination include: (1) the number of violations of a particular type experienced by the card issuer during a prior period, (2) the costs incurred by the card issuer during that prior period as a result of those violations; and (3) at the card issuer’s option, reasonable estimates of changes in the number of violations of that type and the resulting costs during an upcoming period. Losses and associated costs (including the cost of holding reserves against potential losses) are not costs incurred by the issuer. Amounts charged by third parties as a result of the violation are generally costs incurred by the issuer (for instance, bank fees for a returned check). Special rules apply if the third party imposing the charge upon the issuer is an affiliate or subsidiary of the issuer.
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Fees Based on Deterrence – If basing the fee on deterrent effect, the issuer must have determined that the dollar amount of the fee for violating the account terms or other requirements is reasonably necessary to deter that the type of violation for which the fee is imposed. In order to determine that the dollar amount is reasonably necessary to deter the violation, the issuer must use an empirically derived, demonstrably and statistically sound model that reasonably estimates the effect of the dollar amount on the fee or the frequency of the type of violation. A model that reasonably estimates a statistical correlation between the imposition of the fee and the frequency of a type of violation is not sufficient. Instead, the model must reasonably estimate that, independent of other variables, the imposition of a lower fee amount would result in a substantial increase in the frequency of that type of violation.
Safe Harbor Amounts: In lieu of the above analysis, the proposal provides safe harbor amounts that issuers may impose for violations. Issuers are permitted to rely on these safe harbors without engaging in the cost or deterrence analyses. The Board is soliciting comment as to the proper amount for these safe harbors. Currently, the proposal would permit issuers to charge the greater of: (i) a yet-to-be-identified fixed dollar amount (adjusted annually by the Board to reflect changes in the Consumer Price index) or (ii) 5% of the dollar amount associated with the violation, provided that the dollar amount of the fee does not exceed a yet-to-be-identified fixed dollar amount, adjusted annually by the Board to reflect changes in the Consumer Price Index.
Prohibitions: Notwithstanding anything to the contrary above (including the safe harbor amounts), the proposals prohibit charging a fee for violating the terms that exceeds the dollar amount associated with the violation at the time the fee is imposed. For instance, if the account balance exceeds the credit limit by $5, the creditor is prohibited from imposing an over-the-limit fee of more than $5, regardless of the safe harbor amount in the final rule. Similarly, if the periodic payment due is $20, the late fee may not exceed $20. The dollar amount associated with a returned payment is the amount of the required minimum periodic payment due during the cycle in which the payment is returned to the card issuer.
In addition, card issuers could not impose a fee when there is no dollar amount associated with the violation, such as (1) fees for transactions that the card issuer declines to authorize, (2) fees based on account inactivity, and (3) fees imposed for closure or termination of the account.
Finally, the rule prohibits card issuers from imposing more than one fee for violating the terms or other requirements of a credit card account based on a single event or transaction. A card issuer may at its option comply with this prohibition by imposing no more than one fee for violating the account terms or other requirements during a billing cycle.
Effect on Periodic Statement: In disclosing the late fee that may be imposed as a result of late payment, creditors may state a range of fees, or the highest fee and an indication that the fee imposed could be lower. Thus, except when a range of fees is disclosed, creditors must use an “up to” reference for the disclosure of the late fee that would apply, as opposed to a static dollar amount. The “up to” reference takes into account that the fee that may be charged could be limited by the prohibition on charging fees in excess of the dollar amount associated with the violation.
II. Reevaluation of Rate Increases
General Rule on Rate Increases: The proposal also would require card issuers that have increased an APR on an account based on the credit risk of the consumer, market conditions, or other factors, or increased a rate on or after January 1, 2009 for which 45 days’ advance notice is required (such as for default), to evaluate whether such factors have changed. If factors have changed, and a reduction in the APR is indicated, the issuer must reduce the rate not later than 30 days after completion of the evaluation.
Issuers are required to have reasonable written policies and procedures in place to review the factors. This review would have to occur at least once every six months after the initial rate increase.
Issuers are not required to base their reviews on the same factors on which the increase was based. The issuer may, at its option, review the factors on which the rate increase was originally based, or may review the factors that it currently considers when determining the APR applicable to its credit card accounts. If the rate is increased due to a default of 60 or more days, the creditor is not required to review factors prior to the sixth payment due after the date of increase.
The requirement to review accounts also applies to accounts acquired from other issuers. For acquired accounts, creditors may review based on the factors used by the issuer from whom they acquired the accounts, or may use the factors the new account owner currently considers in determining APRs for its accounts. However, if a card issuer reviews all of the accounts it acquires in connection with a portfolio acquisition as soon as reasonably practicable after the acquisition of the accounts, in accordance with the factors that it currently uses in determining the rates applicable to its credit card accounts, the requirement to periodically review rate increases would apply only to accounts for which the rate was increased after acquisition as a result of applying the acquiring issuer’s factors. The card issuer is not required to review changes in factors for any increases made prior to the card issuer’s acquisition of such accounts. This exception for acquired portfolios does not apply for accounts that, as a result of the issuer’s review, are subject to, or continue to be subject to, an increased rate as a penalty.
The obligation to review factors ceases if the issuer reduces the APR to the rate applicable immediately prior to the increase (if variable, using same formula – index and margin), or to a lower rate than what applied immediately before the increase. The requirement to reevaluate does not apply to charged-off accounts. The Board is soliciting comment on whether the obligation to review increases should terminate after some specific period of time following the increase – for instance, after five years.
Effect on Change in Terms and Chang in Rates Notices: If a card issuer raises the rates on an account, the 45 days’ advance notice to the consumer of the rate increase must include a statement of no more than four principal reasons for the rate increase, listed in their order of importance. The Commentary clarifies that issuers are permitted to describe the reasons in general terms. For example, the notice of a rate increase triggered by a decrease of 100 points in the consumer’s credit score may state that the increase is due to “a decline in your creditworthiness” or “a decline in your credit score.” Similarly, notice of a rate increase triggered by a 10% increase in the issuer’s cost of funds may be disclosed as a “change in market conditions.”
Daniel J. Laudicina is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Dan at 410-865-5435 or by email at dlaudicina@hudco.com.