This May, Sen. Carl Levin (D-MI) introduced the Stop Unfair Practices in Credit Cards Act (S.1395), pro-consumer legislation that could significantly impact the credit card industry, and which will possibly have a ripple-effect impact on the securitization of credit card receivables. Sen. Levin introduced the legislation after an investigation by the Permanent Subcommittee on Investigations, which he chairs, into the billing practices of the credit card industry.
Sen. Claire McCaskill (D-MO) was an original co-sponsor of the bill, and it has since garnered three additional co-sponsors: Sen. Patrick Leahy (D-VT) on May 21, Sen. Richard Durbin (D-IL) on June 4, and Sen. Jeff Bingaman (D-NM) on June 27. Upon introduction on May 15, the bill was referred to the Senate Committee on Banking, Housing and Urban Affairs, where it remains as of Aug. 1 awaiting review.
The Unfair Practices Act would prohibit certain practices widely used by the credit card industry, such as charging interest on the entire debt accumulated during a billing cycle, even when most of it is paid on time, and charging customers to pay their bills by phone or online. In addition, the measure would limit the penalty interest rates - often charged when a customer makes a late payment or exceeds the credit limit - to 7%, and prohibit charging interest on late fees or over-the-limit fees. Companies would also be barred from applying customers' payments to the portion of debt with the lowest interest rate, a common practice in the industry.
Whether the bill will continue to move forward depends in part upon whether Senate Banking Committee Chairman (and current presidential candidate) Christopher Dodd (D-CT) introduces an alternative, less aggressive version of the legislation, which some analysts and lobbyists have speculated is likely. Even if Sen. Dodd does not offer an alternate bill, however, Sen. Levin's bill stands to provide the needed leverage for Congress to negotiate with the industry to make voluntary changes to their billing practices. But Sen. Levin insists that the practices addressed by the proposed legislation have become, "too entrenched and too profitable" for credit card companies to take action on their own, and that "Congress needs to enact pro-consumer legislation to put an end to these unfair practices."
The likelihood of whether Congress will, in fact, take action depends on the timing of the measure, which was introduced as 2008 presidential campaigns
continue to gather steam. If consumer advocacy were to become a hot topic in the presidential election cycle, the bill would stand a good chance of being quickly voted on by the Banking Committee and ushered to the front of the chamber's agenda for a vote by the entire Senate. In the absence of such incentive, however, the bill's future remains uncertain. In fact, the bill could remain stagnant under the purview of the Banking Committee, in which case it will die at the end of the legislative session which typically adjourns in late November or December.
The political landscape has been further complicated by the Federal Reserve Board's unveiling of new proposed consumer protection rules for the credit card industry, which followed in the wake of Sen. Levin's introduction of his measure. The Federal Reserve's proposed rules would significantly change the disclosure requirements of the current truth-in-lending regulations, drastically expanding both the list of company practices that require giving advance notice to customers and the number of days of advance notice required. The Fed initiative would call for companies to print disclosure statements in larger type, require the statement to include how much interest the customer has paid during the calendar year, and force companies to apply payments to the debt carrying the highest interest rate.
Thus far, the Federal Reserves's proposed rules have met with approval from credit card issuers and other industry groups, such as the American Bankers Association. These groups hope that tightening disclosure requirements will head off Congress's attempts to pass harder-line pro-consumer legislation that prohibits practices, rather than merely requiring their disclosure. Final rules will not be issued until after September, when the comment period closes.
In response, Sen. Levin and consumer advocacy groups such as the National Consumer Law Center and the Consumer Federation of America insist that the Fed's rules do not go far enough, and that Congress needs to pass sweeping legislation that strictly prohibits certain arguably abusive practices.
It remains unclear how the passage of such legislation would impact securitizations of credit card receivables. Rating agencies say they are weighing the effect of such legislation. It is possible that the billing restrictions established by the legislation could reduce excess spreads, which represent the difference between the gross yield on a portfolio of receivables and the cost of financing the receivables, including the expenses of the transaction. A reduction in excess spreads would amount to a reduction in profits for asset-backed securitization issuers. The bill could also diminish cash flow on outstanding deals, which in turn could lead to lower yields on bonds backed by accounts that are subject to the new restrictions.
Credit card asset-backed securitizations have enjoyed relatively stable credit performance, however, generally having a lower default and reinvestment risk than many other securitizations in other sectors. As a result, excess spreads are likely to remain at levels acceptable to investors. While it's fair to assume that Sen. Levin's bill would not be an easy pill for credit card companies to swallow, it is not likely that the legislation's restrictions would so upset the stability of outstanding issuances of credit card backed securities as to significantly impair the market for credit card securitizations.
Howard Mulligan is based in McDermott Will & Emery's New York office. He is a member of the firm's corporate department, where his practice focuses on a wide range of securitizations and structured finance transactions. Mulligan also has experience in insolvency matters, workouts and restructurings of debt, debtor-in-possession financings, and the securitization of receivables of reorganized companies emerging from bankruptcy cases.
Alexandra Moosally is also based in the firm's New York office. She is also part of the McDermott's corporate department focusing on structured finance.
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