CARD Act Restrictions for Variable Rate Credit Cards with Floors The Federal Reserve Board (Board) recently issued rules to implement most of the provisions of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD Act). Under certain of these provisions, which will be effective as of February 22, 2010, card issuers, such as credit unions, will only be able to raise their credit card rates under specific circumstances. One of these is when there is a variable rate and increases in the rate are based on a change in a publicly-available index that is not under the card issuer's control. These provisions generally follow the statutory requirements of the CARD Act. However, in the official staff commentary that was just released with these rules, the Board has indicated that the ability to raise rates under these circumstances will not apply if the issuer imposes a floor (a fixed minimum rate) that will not permit the rate to decrease below that level, even if there are reductions in the index that would otherwise result in lowering the rate. These provisions were not included in the proposed rule or proposed official staff commentary, which means not only did credit unions and others not have an opportunity to comment on these restrictions, but also those credit unions that use floors will now need to immediately assess their options, due to the rapidly approaching February 22, 2010 effective date of these final rule provisions and commentary. In a typical example, a credit union may use the Prime Rate as an index and add a 2% margin. Since the Prime Rate is currently at 3.25%, this results in a rate of 5.25%. However, such a low rate does not adequately compensate for the cost and risks of the credit card so the credit union in this situation would impose a floor that would be significantly higher than 5.25%, such as 9%. In these situations, the Board has indicated that after February 22, 2010, if issuers continue to apply the floor, the card issuer cannot apply increases in the variable rate to existing balances pursuant to Section 226.55(b)(2). This, in essence, will prohibit credit unions from offering a variable rate credit card account with a floor that does not permit the variable rate to decrease consistent with reductions in the index. Shortly after the rules were issued, CUNA staff, Leagues, and credit unions contacted the Board to raise concerns with these new provisions. As a result, the Board staff outlined the options available to credit unions in these situations, which are provided below under the following two categories:
Option 1 – Convert the variable rate to a fixed rate that will apply to existing balances and change the margin for future transactions Under this option, it is necessary for credit unions to address the existing and new balances: Existing Balances - Credit unions may convert the credit card’s existing outstanding balance to a fixed rate in which the floor for the current variable rate account becomes that fixed rate. The Board attorneys indicated that no 45-day change-in-terms notice would be required prior to February 22, 2010, out of recognition that this change is required since the interest rate floor will conflict with the CARD Act requirements and due to the short period of time that credit unions have to comply with these requirements. However, the Board indicated that a change-in-terms notice with regard to this conversion to a fixed rate should be given within a “reasonable” time after February 22, 2010. It is not necessary to provide the notice of conversion separately. The term “reasonable” is not specifically defined, but one option would be to provide a notice of this change that would be sent with an upcoming periodic statement. New Balances - As for new balances, the credit union would not have to apply a fixed rate but would have to make changes. One option is that the credit union could change the variable rate by increasing the margin so the index plus the margin equals the current floor. To increase the margin, a 45-day change-interms notice will be required. However, this does not necessarily have to be accomplished before February 22, 2010. This change can be delayed until closer to the time that the index increases to the point in which the floor will no longer apply. The Board staff indicated that perhaps the most efficient means to implement this option may be for the credit union to provide one notice that both informs the member that the existing balance will now be at a fixed rate that is equivalent to the current rate, or floor, and also informs the member that the margin is being increased for new transactions. It should also be noted that under the CARD Act requirements, the existing balance subject to this fixed rate will be the balance that exists 14 days after the notice is sent. Therefore, the amount of the existing balance covered under this new fixed, permanent rate will likely increase to the extent that this notice is delayed, which could be detrimental to the credit union since they may no longer change this rate while this balance exists.
Option 2 – Keeping a variable rate for existing and new balances Credit unions with a floor that exceeds the current index and margin that want to maintain a variable rate for both existing balances and new transactions must eliminate the floor. A credit union may remove or eliminate the floor without providing a change-in-terms notice to its members. Regulation Z Section 226.9(c)(2)(v)(A) states that no notice is required when the change involves a reduction in any component of the finance charge. However, the next time the variable rate adjusts, the rate would be based upon the current index and margin, which may not adequately compensate the credit union for the cost and risks of the credit card account. For the example described above, this means the rate will drop to 5.25%. Although this may be unappealing, there may be reasons that a credit union would choose this option. For example, if the rate plus the margin is not too much below the floor, this will allow the credit union to keep their current variable rate without having to decrease it significantly. The credit union will then be able to increase it as soon as the index rises and apply the higher rate to the total balance. The credit union will have to weigh the financial risks involved of lowering the rate now in anticipation of general interest rates rising at some point in the future. Another advantage of this approach may be that credit unions would not have to track separate balances for existing and new transactions, at least in the short-term until other factors cause the credit union to create and track these balances. Situations when the floor is less than the index plus the margin The above options primarily address situations in which the floor is currently higher than the index plus the margin. If the floor is below the index plus the margin, then the credit union may just simply remove the floor at this time. No specific notice to current accountholders would otherwise be required, primarily because this would be considered a favorable change for the consumers and, as stated above, Regulation Z does not require a change-in-terms notice in these situations. However, card issuers would need to change their account-opening disclosures and their application/solicitations to reflect this change, which may be accomplished by way of an insert that could be included with the current disclosures. In any event, until the floor is removed, the rate may not be increased after February 22nd.
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