NEWS, EVENTS, PUBLICATIONS & EMERGING ISSUES

SW&M EMERGING ISSUE
June 18, 2010

FEDERAL RESERVE BOARD ISSUES FINAL RULE ON CREDIT CARD PENALTY FEES AND REEVALUATION OF APR INCREASES

On June 15, 2010, the Federal Reserve Board (the “Board”) published a final rule amending Regulation “Z” that, among other things, requires penalty fees imposed by credit card issuers to be reasonable and proportional to the violation of the account terms and further requires credit card issuers to reevaluate every six months annual percentage rates (“APRs”) increased on or after January 1, 2009 (the “Final Rule”). The Final Rule is effective August 22, 2010. However, there is a special mandatory compliance date of December 1, 2010 for amendments to penalty fee disclosures, discussed in more detail below. What follows is a brief summary of the major provisions of the Final Rule.

1. Reasonable and Proportional Penalty Fees

The Final Rule permits a credit card issuer to charge a penalty fee for a particular type of violation (e.g., late payment fee) that is based on the costs incurred by the issuer as a result of that type of violation or, as an alternative to the cost analysis, the issuer may utilize safe harbors adopted by the Board.

Fees Based on Costs. The Final Rule permits issuers to use penalty fees to pass on the costs incurred as a result of violations while ensuring that those costs are spread evenly among consumers so that no individual consumer bears an unreasonable or disproportionate share. The Final Rule provides guidance regarding the type of costs incurred by card issuers as a result of violations, which include, but are not limited to, third party charges (e.g., the issuer is charged a specific amount by a third party for each returned payment) and costs incurred as a result of late payments (e.g., collection costs, such as the cost of notifying consumers of delinquencies and resolving those delinquencies). However, the official commentary provides that certain amounts must be excluded from the analysis, including losses and related costs (such as the cost of holding reserves against potential losses and the cost of funding delinquent accounts). In order to ensure that penalty fees are based on relatively current cost information, the Final Rule requires issuers to reevaluate their costs at least annually.

Safe Harbors. As an alternative to the cost analysis, your credit union may choose to utilize the safe harbors adopted by the Board. Specifically, the Final Rule generally permits issuers to impose a $25 penalty fee for the first violation and a $35 fee for any additional violation of the same type during the next six billing cycles. For example, if a consumer paid late during the January billing cycle, a $25 late payment fee could be imposed. If one of the next six payments is late (i.e., the payments due during the February through July billing cycles), a $35 late payment fee could be imposed. These amounts will be adjusted annually to the extent that changes in the Consumer Price Index would result in an increase or decrease of $1.

Examples of Penalty Fees. What penalty fees are covered by the Final Rule? According to the official commentary, a penalty fee includes any charge imposed by a card issuer based on an act or omission that violates the terms of the account or any other requirements imposed by the card issuer with respect to the account, other than charges attributable to periodic interest. Such fees include: late payment fees, returned payment fees, any fees for an over-the-limit transaction and any fee imposed by a card issuer if payment on a check that accesses a credit card account is declined. Balance transfer fees, cash advance fees, foreign transaction fees, annual fees and other fees imposed in connection with the issuance or availability of credit, debt cancellation or debt suspension fees, fees for making an expedited payment, fees for optional services (e.g., travel insurance) and fees for reissuing a lost or stolen card are not considered penalty fees subject to the new restrictions.

2. Prohibited Fees

Under the Final Rule, there are three categories of prohibited fees. First, and notwithstanding the safe harbors described above, the Final Rule prohibits card issuers from imposing a fee that exceeds the dollar amount associated with the violation. For example, if a consumer does not make a $20 minimum payment by the payment due date, the late payment fee cannot exceed $20, even though the safe harbors would otherwise permit imposition of a higher fee.

Second, card issuers are prohibited from imposing fees for violating the terms of a credit card account when there is no dollar amount associated with the violation. As a result, card issuers cannot impose fees for: transactions that the card issuer declines to authorize, account inactivity (e.g., fees based on the consumer’s failure to use the account to make new purchases), and the closure or termination of an account.

Finally, the Final Rule prohibits card issuers from imposing multiple penalty fees based on a single event or transaction. For example, an issuer may not charge a late payment fee and a returned payment fee based on a single payment. The official commentary provides a number of examples to illustrate the application of this rule.

3. Reevaluation of Rate Increases

For any APR increases on or after January 1, 2009 that are (or were) based on the credit risk of the consumer, market conditions or other factors, the Final Rule requires card issuers to review the account at least once every six months and, if appropriate based on that review, reduce the APR. If based on its review a card issuer is required to reduce the APR applicable to an account, the Final Rule requires that the APR be reduced within 45 days after completion of the evaluation. The Final Rule also requires card issuers to have reasonable written policies and procedures in place to conduct the review.

Factors Relevant to Reevaluation of APR Increases. The Final Rule generally permits a card issuer to review either the same factors on which the APR increase was originally based, or to review the factors that the issuer currently considers when determining the APRs applicable to similar new credit card accounts. In addition, there is a special provision for APR increases imposed between January 1, 2009 and February 21, 2010. For APRs increased during this period, the Final Rule requires an issuer to conduct its first two reviews by using the factors that the issuer currently considers when determining the APR applicable to similar new credit card accounts, unless the APR increase was based solely upon consumer-specific factors, such as the consumer’s delinquency or default.

Obligation to Reevaluate APR Increases Continues Indefinitely. A card issuer must continue to review a consumer’s account every six months unless the APR is reduced to the APR in effect prior to the increase. Accordingly, in some cases, this obligation may continue indefinitely. The Board expressly declined to adopt a specific time limit on the obligation to reevaluate APR increases.

4. Amendments to Penalty Fee Disclosures

As you may recall from prior regulations issued by the Board, the tabular format requirements for the application and solicitation table (commonly referred to as the “Schumer Box”), the account-opening table and periodic statements become effective on July 1, 2010. Model forms were issued by the Board in January of this year to assist with compliance with the tabular formatting requirements.

Because of the new rules concerning credit card penalty fees, the Final Rule includes updated model forms relating to the Schumer Box, the account-opening table and periodic statements to provide assistance with disclosing penalty fees. While the differences between the model forms issued in January and those issued earlier this week are minor, the fact remains that some issuers will have to once again revisit and revise their disclosure forms to reflect compliance with the Final Rule.

In recognition of the timing concerns, the Final Rule provides some leeway with regard to penalty fee disclosures. Specifically, although card issuers may not charge penalty fees that are inconsistent with the Final Rule after August 22, 2010, the Board established a mandatory compliance date of December 1, 2010 for the amendments to the penalty fee disclosure requirements. Accordingly, until December 1, 2010, a card issuer complies with the Schumer Box, account-opening table and periodic statement disclosure requirements if it discloses a penalty fee that exceeds the amounts permitted by the Final Rule. For example, if your credit union imposes a late payment fee of $39, it may continue to do so until August 22, 2010, and may continue to disclose the amount of its late payment fee as $39 until December 1, 2010 even if – consistent with the safe harbors – your credit union does not actually impose a fee that exceeds $35. However, your credit union may begin to disclose the amount of the late payment fee as “up to $35” or otherwise comply with the disclosure requirements prior to December 1, 2010.

If your credit union has any questions regarding the Final Rule, please do not hesitate to contact our office.

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