NEWS, EVENTS, PUBLICATIONS & EMERGING ISSUES

SW&M EMERGING ISSUE
January 29, 2010

FED PLAYS “GOTCHA!” WITH NEW VARIABLE RATE CREDIT CARD RESTRICTIONS

As you know, on January 12, 2010, the Federal Reserve Board (“Fed”) issued its Final rule amending Regulation “Z” implementing certain provisions of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (“Credit CARD Act”). The Final rule is effective February 22, 2010. Based on the original language of the Credit CARD Act and proposed Regulation “Z” issued in October, 2009, credit card issuers were placed on notice that on and after February 22, 2010, they could no longer increase interest rates on credit cards except under very specific circumstances.

One of the exceptions is a variable rate credit card where the interest rate varies according to an index that is not under the card issuer’s control. In anticipation of the February 22, 2010 effective date, a number of credit unions changed from fixed rate to variable rate credit card products in order to take advantage of the exception. In addition to this program change, many of these credit unions established a “floor” interest rate to manage interest rate risk. Neither the Credit CARD Act nor the proposed Regulation “Z” rule indicated that establishing a floor interest rate was inconsistent with the variable rate exception.

In a move that has raised concerns within the credit union industry, the Final rule introduced the notion for the first time that the use of a floor interest rate was inconsistent with the variable rate exception. Specifically, in the official Commentary to Regulation “Z” § 226.55(b)(2), the Fed has now clarified that the use of a floor interest rate is inconsistent with the variable rate exception because the issuer “exercises control” over the operation of the index by implementing a floor. As a result, credit unions with floor interest rates must use the advance notice exception under new Regulation “Z” § 226.55(b)(3) to increase rates which, among other things, requires a 45-day advance written notice, triggers the right to reject, and prohibits the application of an increased rate to outstanding balances.

What does this mean? Among other things, this change will likely have an adverse effect on credit unions in terms of below market rates applicable to credit card balances in the event of an increase in the applicable index (an event that is sure to come over time). This will make it more difficult to manage interest rate risk and could place credit union operations into a loss position due to the loss of a floor. In addition, this change could translate into significant operational problems if a credit union’s credit card processor cannot account for multiple balance “buckets” with different interest rates, which will make it difficult to comply with the new periodic statement requirements.

While the Fed’s interpretation of the use of a floor applies to all card issuers, credit unions appear to be particularly impacted. Credit unions typically have lower rates and now lower margins. For many credit unions, imposing a floor was a means to manage interest rate risk. Recent media reports indicate that several of the largest card issuers do not use floor rates; rather, they likely have higher margins. If your credit union decides to eliminate its floor rate, your credit union may be faced with the unpleasant option of increasing margins at the same time. Doing so, however, will have the unintended consequence of harming consumers by imposing higher card rates. For those credit unions that recently issued notices to members informing them of the change to a variable rate product with a floor, a follow-up notice eliminating the floor and increasing the margin may create member confusion or concern that their credit union is acting “just like the big banks” by increasing rates.

We understand that CUNA and other trade groups have been in contact with the Fed on this issue and recent reports indicate that the Fed may provide additional guidance by the end of the month. However, credit unions are well advised to review their portfolio and internal procedures to determine whether eliminating a floor rate is in your best interest. If your credit union decides to eliminate the floor rate, there may be some creative ways to give some benefit back to cardholders (e.g., interest rate rebates or ramping up rewards programs). If your credit union has any questions regarding the Final rule and/or would like our assistance in analyzing potential next steps, please do not hesitate to contact us.

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