This past month, credit card reform has been in the spotlight.
Just last Wednesday the Treasury Department released a statement showing support for credit card reform.
The statement said: The Federal Reserve has taken a strong first step toward improving disclosures and ending unfair practices. Leaders in the House, including Chairman [Barney] Frank and Representatives [Carolyn] Maloney and [Luis] Gutierrez, and in the Senate, including Chairman [Christopher] Dodd and Senator [Carl] Levin, have drafted bills that will codify and strengthen these new regulations. The administration strongly supports these efforts as key components of comprehensive consumer protection and overall regulatory reform.
On the same day the statement was released, Treasury Secretary Tim Geithner, along with Congresswoman Maloney (D-NY), met with consumer groups and credit card holders to discuss credit card reform. The discussion focused on the Credit Card Holders Bill of Rights of 2009 (HR 627). As of press time last Thursday, HR 627 was passed by the House of Representatives. The measure was approved by the House Financial Services Committee, 49-18, on April 22.
Meanwhile, on April 23, Senators Charles Schumer (D-NY) and Dodd called on the Federal Reserve to freeze credit card interest rates that are tied to existing balances until stricter rules take effect. At the same time, President Barack Obama met with card issuer executives to pursue consumer protections. He also made it clear that he will sign credit card legislation.
Dodd last February reintroduced The Credit Card Accountability, Responsibility and Disclosure Act, better known as The Credit Card Act. This bill would go beyond the card regulations finalized by the Fed back in December 2008, which would define several common practices, like double-cycle billing and universal default, as unfair or deceptive. The Fed's rules would not go into effect until July 1, 2010, but Dodd's bill would be implemented nine months after enactment.
Industry observers praised Dodd's bill. "The House, the Senate and the Federal Reserve are all tackling credit card reform, but there is no legislation to actually help consumers right now during this economic crisis," said Bill Hardekopf, CEO of LowCards.com. He said that while the Fed's regulations do not take effect until mid-next year, "credit card issuers have tightened lending and increased rates to protect and help themselves."
Issuers Oppose Changes
ABS credit card issuers have opposed the changes included in the Fed regulations and the Maloney/Dodd bills, which, according to sources, do not differ substantially. The issuers' arguments are based on the fact that the credit card business, they said, has always been based on risk-pricing.
"There's a difference between credit card debt and a home loan; every time borrowers use credit cards, they're making a new credit decision," a card issuer said. He added that borrowers are fully informed about the terms of their credit card use. "We're obligated by law to disclose terms clearly using a font size mandated by law," he said.
The issuer said that some firms have already started changing the terms on credit card borrowers in advance of the implementation of the Fed rules. This is to give these issuers time to adjust their data systems to cope with the legislative changes. "Even the Maloney bill basically gives issuers a year prior to implementation because it's physically impossible to apply these systems without this time."
He added that a lot of people understand that credit companies are in the business to make money. With less flexibility to price credit, "we have to find other ways to offset the loss - you have to reduce your expenses and your workforce."
The issuer source said that the changes contemplated by the Maloney/Dodd bills will raise the cost of borrowing for higher-credit borrowers. "Now even people with good credit are not going to get low-interest loans," the issuer source said, adding that popular media is already full of stories about good borrowers losing their credit lines.
He said that measures such as Maloney's bill requiring issuers to apply payments proportionately to card balances with different interest rates are going to make the credit card business "far less profitable."
However, these changes are not going to affect credit card issuers equally. "For some issuers, the Maloney/Dodd bills will be more impactful," the issuer said. For instance, some issuers use universal defaults and double-cycle billing on a small portion of their portfolios, while some don't at all. "The level and extent of it are not going to hit people equally."
Some believe that these legislated changes will likely promote market discipline. Glenn Schultz, a managing director at Wachovia Securities, said that despite apprehension about current credit card legislation, these could promote transparency and perhaps encourage people to pay off their balances.
"These reforms will remove the credit card issuers' ability to price credit in real time and not allow weaker credits to be subsidized within portfolios," Schultz said. "This has caused credit card companies to raise rates on their customers before these regulations take effect. It's basically employing practices that would boost portfolio yield." One measure that he mentioned is to apply common rates to all customers, say 23%, without differentiating between customers with better credit.
But this is not necessarily negative. "In another sense, however, the legislation is about increasing transparency. Applying a single rate would make it clear to the consumers what rate they are really paying," Schultz said. The higher rate, he said, might even encourage consumers to find ways to pay their balances off.
Rating Agency Perspective
Upcoming legislative changes in the credit card industry are factored into Fitch Ratings' analysis. "Our stress scenarios consider issues detrimental to portfolio yields and payment rates, including legislative uncertainty and other potential caps that may be in the works," said Michael Dean, a managing director at Fitch Ratings.
Dean said that although it's still pretty early to see the full results, some issuers have stepped up practices related to loss mitigation. They have also re-priced their portfolios in anticipation of the upcoming legislative changes as well as to make up for the higher charge-off rates. Some of the actions on the portfolio yield side have helped offset the higher charge-offs with respect to excess spread, Dean said.
However, Fitch does not give any credit to the extra measures taken by issuers to boost performance or protection. "When rating these transactions, we look at credit enhancement on the bond independently from any actions that may be taken by the issuer," Dean said.
Christopher O'Connell, senior vice president at DBRS, said that based on discussions he has had with credit card issuers, there seems to be anecdotal evidence of re-pricing credit card risk to account for pending credit card regulation and the unexpected performance in some of these portfolios. Yields on many card programs are declining despite this because cardholders are using their cards less frequently. This means the interchange is declining, pulling down the aggregate yield on most of these issuer programs.
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