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Mar 05, 2010
Categories: Consumer Lending

It Isn't the Size of the Dog in the Fight, it is the Size of the Fight in the Dog

Posted by Anthony Demangone

As I pointed out yesterday, the Fed issued a proposed rule to implement the final two provisions of the Credit CARD Act.  Those two provisions would be:
  1. Penalty fees by credit card issuers must be reasonable and proportional to the violation of the account terms.
  2. Credit card issuers must reevaluate at least every six months any APR increase done on or since January 1, 2009.  
There are only two provisions, so this can't be that bad, right?  Like the title of this post says, don't be fooled by the size of a proposal, or the number of provisions.  I scanned the 157 pages last night after Das Twins went to bed, and I can tell you this - this proposal is both tricky and paternalistic.  And that's a deadly combination.

Reasonable and proportional penalty fees. 
Under the proposal, if you want to charge a penalty fee, you'll have to do it in one of the allowable methods.
  • Fees based on costs, if you can show that the fee represents a reasonable proportion of the total costs caused by the violation. 
  • Fees based on deterrence,  if you can show that the dollar amount of the fee is 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.
If you use either of these methods, you must reevaluate your methodologies at least every 12 months.   The Fed will provide a safe harbor, but it seeks comments as to what that amount should be. 

The rule also creates a number of prohibitions regarding penalty fees.  For example:
  1. You can't charge a penalty fee for more than the underlying transaction.  For example, if a member goes over the limit by $5, you can only charge a $5 over the limit fee.
  2. If there is no dollar amount associated with the violation, you can't charge a fee.  So, you can't charge a fee if a transaction is declined, when the member closes an account, or if there is inactivity on the account. 
  3. You may not charge more than one fee for violating the agreement based on a single event or transaction. 
Again, there is a safe harbor.  The safe harbor indicates that you can comply with these requirements by charging a fee for violating a term of the agreement, if the fee does not violate a prohibition and does not exceed the greater of: 
  1. A flat, safe harbor fee that the Fed will determine; or 
  2. 5% of the underlying transaction, not to exceed an amount to be determined by the Fed.  
Reevaluation of Rate Increases
The second part of the Fed's proposal will require credit unions to reevaluate the decision to increase the APR on a credit card at least every 6 months, if the increase was done on or after January 1, 2009.  These requirements will be housed in 226.59.  Here are some general thoughts:
  • You'll have to review the decision that led to the rate increase.  You don't have to use the same factors that led to the rate increase, but you may.  Based on your review, you'll need to reduce their rate as appropriate.
  • If you do decide that a rate reduction is required, there's no explicit requirement to reverse all of the APR increase.  BUT...the Fed is contemplating a requirement that you'll have to review such accounts every 6 months until you do reduce the rate all the way back to what it was before the increase. 
There's a thumbnail sketch of the proposed requirements.  I didn't touch on everything. For example, because the amount of penalty fees may vary given on the situation, your fee disclosures may need to be updated. Most likely, you'll disclose penalty fees as "up to $20."  Model forms have been amended accordingly.

We'll dig into the details in the coming weeks, so stay tuned.  But for now, here's my take-away points.
  • We need your help.  You need to review this and comment.  Comments are due 30 days after this puppy is published in the Federal Register.  We're working on a Regulatory Alert, and we welcome NAFCU member comments.  But please consider commenting yourself.
  • You need to alert your budget people that income very well may drop because of this regulation.   Remember, you may see a drop in your fees, the number of your fees, as well as the fact that may have to reduce interest rates that you raised after January 1, 2009.    
With that, have a great weekend, everyone.  

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