Compliance Blog

Blog Home
Jan 19, 2010
Categories: Consumer Lending

Floors; Overview Document

Posted by Anthony Demangone

Today, I wanted to discuss one aspect of the recently-issued Regulation Z final rule that does not match up with the proposal.

Floors.  Apparently, the Fed does not like the use of interest rate "floors" anymore for credit cards.  This comes from page 317 of the final rule.
Consumer groups and a member of Congress raised concerns about two industry practices that, in their view, exercise control over the variable rate in a manner that is inconsistent with revised TILA Section 171(b)(2). First, they noted that many card issuers set minimum rates or “floors” below which a variable rate cannot fall even if a decrease would be consistent with a change in the applicable index. For example, assume that a card issuer offers a variable rate of 17%, which is calculated by adding a margin of 12 percentage points to an index with a current value of 5%. However, the terms of the account provide that the variable rate will not decrease below 17%. As a result, the variable rate can only increase, and the consumer will not benefit if the value of the index falls below 5%. The Board agrees that this practice is inconsistent with § 226.55(b)(2). Accordingly, the Board has revised comment 55(b)(2)-2 to clarify that a card issuer exercises control over the operation of the index if the variable rate based on that index is subject to a fixed minimum rate or similar requirement that does not permit the variable rate to decrease consistent with reductions in the index. (Emphasis added.)
What does this mean?  Are floors illegal?  Not really.  Remember, section 226.55 now states that you cannot change an interest rate on a credit card unless the change fits into one of the possible scenarios listed in the section.  One of those is the variable rate exception.  With a floor, that exception is now gone.  So, if you have a floor now, you really have a very complicated non-variable rate.  But the floor can remain. Only now, you'll need to issue a 45-day change in terms to move the rate up.  And that triggers a right to reject.  Here's a thought:  If your floor arrangement has "wiggle room, there may be no rush to remove the floor from existing accounts.  (But you may want to fix this for new accounts.)  Here's why:

Let's use a hypothetical situation.  Let's say you have a credit card that is prime (3 percent)  + a margin (5 percent), with a floor of 11 percent.  So, without a floor, the rate would be 8 percent.  But because of the floor, the member's APR is 11 percent.  Do you have to send out new disclosures right away to remove the floor and increase the margin?  Not necessarily.  In this hypothetical, prime could go up 300 basis points before the member's APR exceeds 11 percent.  That gives you "wiggle room" - some additional time.  With that in mind, you could sit back until you think the Fed will raise rates that would push the APR past 11 percent.  

But the bottom line is this: I think the guidance is misguided.  Here's why:
  • Floors are a solid way of managing interest rate risk, which the Fed wants us to do - as evidenced by their decision to join in on the FFIEC interest rate risk guidance document.   
  • The guidance will accomplish nothing.  Organizations will simply amend their agreements to get rid of floors.  But they'll also increase the margin so that the interest rate risk is properly managed.  But in doing so, they'll have to issue "change in terms" notices to all affected borrowers.  As I see it, the only beneficiary here is the U.S.P.S.  In addition, it will give all of us a black eye.  Consumers will think that their credit union or bank is evil (for increasing the margin) or incompetent (if they recently issued changes in terms that included a floor).   
  • My colleague Steve pointed out that some consumers may actually be harmed by this.  Let's say a credit union has a variable rate with a margin, with a floor of 9.99 percent.  With rates so low, the margin + prime is at, say, 7 percent.  In this hypothetical, prime could increase 299 basis points before the member sees an increase on their credit card's APR.  But take away their floor, and most sensible organizations facing corporate assessments, high delinquencies, etc., will take steps to keep the interest rate the same.  So they'll remove the floor but increase the margin to make the rate...9.9 percent.  Only now, if the prime goes up at all, the member will see an increase in their rate immediately.  And those increases continue each time the Fed adjusts interest rates. 
Finally, this change is the equivalent of a regulatory meteorite.  It came out of nowhere, and we did not have a chance to comment on the idea.  I spoke with a credit union that just sent out 40,000 change in terms notices that include a floor.  Postage alone will be roughly $20,000 to correct the issue.  And that doesn't take into account member confusion.  The credit union professional told me this: if they had known that this was even a possibility, they would have thought twice about going down this road.  Now they are strongly considering issuing new notices that remove the floor, and....(you guessed it) increase the margin.

This reminds me of a scene from The Wedding Singer.  In the movie, Adam Sandler's character makes a series of poor decisions.  Invariably, someone gives him the perfect piece of advice...after he has made the bad decision and cannot turn back. Below is Adam's response to that advice.


That is my response to the Fed.  Only, there's no way a credit union that implemented a floor could have known what was coming.  Again, they've been hit with a regulatory meteor.  There was no warning on this.  No time for us to comment.  It is frustrating, to say the least.

We'll make the Fed aware of our thoughts.  But I cannot say for sure what the chances are that this will be reversed.
***
Hey NAFCU Member: we're working on a overview document concerning the major Feb. 22 deadlines found within the Regulation Z final rule.  This is a work in progress.  We're getting a ton of phone calls, as you can imagine. So we'll update this as soon as we can.  For now, the document provides an overview, as well as detailed analysis of the following:
  • Consideration of Ability to Repay & Issuing Cards to Consumers Under 21; and  
  • Internet Posting of Credit Card Agreements 
 Members can access the document here.

    Categories