Compliance Blog

Due to some of the Credit CARD Act restrictions, quite a few credit unions are discussing whether to switch from traditional fixed-rate credit cards to variable-rate credit cards.  More have already made the switch.  And, as this Wall Street Journal article notes, big banks have been migrating their accounts as well.    

This discussion comes with plenty of risks to analyze and decisions to make.  I will try to pull them apart and analyze them separately below.  

Section 103 of the Credit CARD Act places restrictions on the use of "fixed" to describe a credit card account.  After February 22, 2010, the credit union will only be able to use "fixed" to describe cards that will never increase - or indicate a period of time where the rate will be fixed (i.e. "fixed rate for two years").  

If you do not want to change to variable-rate cards - and you want to retain the ability to increase rates in the future (via 45-day advance notice subject to the right to cancel) - you will want to refer to your credit cards as "non-variable."  Thus, you would have a "non-variable 9.99% APR" or just "9.99% APR" rather than a "Fixed 9.99% APR."  Remember, after February 22, 2010, if you continue to refer to your non-variable rate credit card accounts as "fixed" and advertise them as "fixed" - you will lose the ability to raise the APR on those accounts (unless you clearly disclose the period of time the card will be fixed).  Work with your marketing folks to make sure everyone is on the same page.

If the credit union decides to switch from a fixed/non-variable rate to a variable-rate, it must give 45-days advance notice and the right to cancel to the member.  What if the change results in a lower APR?  Is the change-in-terms notice and right to cancel still applicable?  Yes, as the Federal Reserve indicates in the official staff commentary:

This makes sense.  Even though the variable rate may be lower, a major term of the account has been changed.  The account's APR will now fluctuate in accordance with an established index, outside of the FCU's control, which allows the APR on the account to increase if the index increases - without advanced notice.

The Credit CARD Act also includes restrictions on raising the APR on outstanding balances.  That restriction becomes effective February 22, 2010.  If the credit union were to switch to variable rates prior to February 22, 2010, that change could apply to the member's outstanding balance on the account.  If the credit union made the switch after February 22, 2010 - only new transactions would have the new variable rate and the outstanding balance would remain at the prior, non-variable APR.

Further, variable-rate accounts have an exception to restriction on raising the APR on outstanding balances.  For example, assume your accounts have a variable 9.99% APR consisting of the WSJ prime rate (ex: 4.99%) and a 5% margin.  If the WSJ prime rate, an index outside of the FCU's control, raises to 5.49% - the FCU's credit card APRs could rise to 10.49% without a requirement for the advance notice and the right to cancel.  The increased APR would apply to the outstanding balance as well as future transactions.

In contrast, if the credit union needs to increase a non-variable rate to address the same interest rate risk - the procedure is not as easy.  The credit union would need to send a 45-day advance notice of the increase in APR - along with the right to cancel - to its members.  If a member does not cancel the change, the change could only apply to future transactions and not the member's outstanding balance.  This is because the exception only applies to variable-rate accounts where the APR increase is outside the FCU's control.  In the non-variable context, the credit union has made the decision to increase the APR.

If the credit union decides to make the switch until after February 22, 2010, the outstanding balances on the accounts will remain at the prior, non-variable APR.  The restriction on raising the APRs on outstanding balances goes into effect on February 22, 2010.  What if the credit union switches to a lower variable-rate APR?  It is unclear how the Federal Reserve's forthcoming proposed regulations will address this situation.  We will know by February 22, 2010 how the Fed answers this question.  

Remember, if the credit union decides to switch from "fixed" or non-variable rates to variable rate for its existing credit card accounts - the 45-day advance notice and right to cancel under 12 C.F.R. 226.9 apply.  Those requirements became effective August 20, 2009.  

As discussed in this blog posting, Section 101 of the Credit CARD Act requires that financial institutions must do a "6-month review" of credit card accounts where the APR has been increased since January 1, 2009 to determine if the same conditions apply.  Senator Dodd has sent letters to the regulators pressing them to examine closely on this issue.  Unfortunately, we do not know how the Federal Reserve will interpret this section.  This subsection will be effective August 22, 2010 - but will apply to increases in APRs since January 1, 2009.  If the credit union is raising APRs (regardless of whether it involves a switch to variable rates), be sure to document the reasons for the increased APRs.  This documentation will come in handy for performing the 6-month reviews and for showing examiners your due diligence.