The Federal Reserve Board has proposed a third round of recent amendments to Regulation Z (Truth in Lending) to implement the provisions of the Credit CARD Act dealing with reasonable and proportional penalty fees and reevaluation of rate increases. Once adopted in final form, the new amendments will become effective on August 22, 2010.

Issued on March 3, 2010, the proposal will have a 30-day comment period once it is published in the Federal Register. The new prohibitions and requirements the proposal would impose on credit card issuers include the following:

  • To charge a credit card penalty fee, such as a late fee, over-the-limit fee, or returned check fee, an issuer would have to determine either that (1) the amount of the fee represents "a reasonable proportion of the total costs incurred by the card issuer as a result of that type of violation," or (2) 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." Total costs may not include losses or reserve costs but could generally include third-party costs. A deterrence determination would have to reasonably estimate that, independent of other variables, a lower fee would substantially increase the frequency of the violation. Either determination would have to be reevaluated at least once every 12 months.
  • Instead of making a cost or deterrence determination, issuers would be able to charge a penalty fee that did not exceed a safe harbor amount equal to the greater of an annually adjusted dollar amount or 5 percent of the dollar amount associated with the violation, up to an annually adjusted maximum amount. The Fed did not propose specific amounts for the dollar amount safe harbor or even hint at its thinking regarding permissible dollar amounts. Rather, it stated in its background discussion that it does not yet have sufficient information to do so and is soliciting comments on what the appropriate amounts should be.
  • In its background discussion, the Fed recognizes that it might be problematic if issuers testing the deterrent effect of different penalty fee amounts are unable to charge fees that exceed the safe harbor limits that take effect on August 22, 2010, whether to complete testing started before that date or as part of a later required reevaluation. As a result, it is soliciting comments on whether it should allow issuers to charge fees above the safe harbor after the effective date when engaged in initial testing or reevaluation. Any study will require expert statistical input, as well as careful legal attention, to avoid potential pitfalls.
  • A penalty fee could not exceed the dollar amount associated with the violation. Thus, a late fee or returned payment fee could not exceed the amount of the associated required minimum payment, and an over-the-limit fee could not exceed the amount by which a consumer has gone over the credit limit. Multiple penalty fees could not be charged for the same event. (For example, a late fee and a returned-check fee could not be charged for a single payment returned for insufficient funds.) No penalty fees could be charged for a violation that does not have an associated dollar amount, such as a declined transaction or account inactivity or closure.
  • An issuer that increases the annual percentage rate based on factors such as the consumer's credit risk or market conditions would have to reevaluate its determination at least once every six months. This requirement would apply to accounts on which there was an APR increase on or after January 1, 2009. An issuer would not be limited to the same factors it considered when increasing the rate but could reevaluate using the factors it currently uses when setting APRs. If a reevaluation showed that a rate reduction was required (whether to the pre-increase APR or some intermediate level), the issuer would have 30 days to reduce the rate. The reevaluation requirement would not apply to rate increases resulting from the reinstatement of a rate that was lowered under the Servicemembers Civil Relief Act or to charged-off accounts.
  • The requirement to reevaluate rate increases at least every six months would also apply to accounts acquired by an issuer. In recognition of the fact that issuers may not have complete information about rate increases that precede an acquisition, the proposal would not require an issuer to reevaluate such increases if the issuer "as soon as reasonably practicable after the acquisition" reviews the acquired accounts using the factors currently used by the issuer to set APRs. The issuer would generally then only have to reevaluate rate increases resulting from that review or subsequent reviews.
  • A notice of rate increase resulting from a change in contract terms or the consumer's default or delinquency would have to include up to four principal reasons for the increase.