Be Prepared for the Credit CARD Act

On May 22, 2009, President Obama signed the Credit Card Accountability, Responsibility and Disclosure Act (the Credit CARD Act) into law. The Credit CARD Act will be effective February 2010, bringing with it new consumer protections and particular challenges for credit card issuers.

The new Act comes at a time of particular stress for US credit card issuers. The rapid rise in delinquencies and charge-offs among their existing credit card portfolios has already cut into profits. Consumers and legislators have been consistently critical of the credit card issuers in this recession for cutting credit lines and raising interest rates on existing card borrowers in an effort to earn some returns in this environment, as well. Issuers like American Express are "paying the price" of their generous issuance practices 2 and 3 years ago with delinquency and loss rates that far out-strip the image of the American Express Card as a card held by only the highest credit-worthy borrower.

At the same time, the actions taken by the US credit card issuers since the onset of the recession portend improving metrics. Card issuers have actually reduced credit lines to their riskier borrowers therefore reducing the size of their future losses. American Express went so far as to offer $300 to certain cardholders to turn their American Express card back into the company. The higher rates of interest are also meant to help the issuers establish more of a financial reserve or cushion against future losses.

But the criticism has resulted in the Credit CARD Act. The Act largely mirrors actions already taken by the Federal Reserve to protect consumers against double-cycle billing, opaque cardholder rights, and the application of "universal default". The Congress chose to take the Fed's ideas and move up the timetable, adding more consumer protections along the way.

Among the changes, the Act prohibits the issuer practice of raising interest rates permanently on borrowers who are delinquent 60 or more days. If the delinquent borrower then pays on time for 6 straight months, the issuer must reinstate the lower rate. Along the line of interest rates, the Act also requires that initial low promotional rates must have a minimum 6 month duration and prohibits increased rates in the first year a cardholder has a new account.

A particularly good feature of the Act is the prohibition against issuers charging borrowers to pay by phone, mail, electronic transfer, or for online payments. The bill also features restrictions against issuing cards to individuals under the age of 21. This will effectively end the massive marketing effort by credit card issuers on college campuses. The scary trend has been the ever-increasing level of consumer debts some students have when they graduate college, on top of ever-increasing student loan burdens.

Credit card issuers may choose to adapt to the Act through a number of strategic changes. First, it will be likely that all cardholders will see an upward drift in interest rates on unpaid balances. Certainly before February 2010, issuers will try to establish some sort of baseline interest rate for the various tiers of credit risk they have in the card portfolio. It will also be likely to see fewer "no annual fee" cards. Because the Act prohibits some of the interest rate adjustments issuers currently have in their tool kit to adjust rates in line with changing cardholder credit risk, issuers will be more likely to seek alternative revenue sources.

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It is also likely that borrowers will see their credit limits trimmed prior to the February enactment. Reducing credit availability in a recessionary period is tricky. It hurts retailers and fails to stimulate the economy, just when economic stimulus is needed. But it also reduces the upper limit for borrowers who are increasingly stressed by the same recession and helps cap potential losses for the issuers. It also may anger the same borrowers resulting in a backlash in the form of reduced repayment, even default. No one can say that the credit card issuers are not going to ultimately act in a manner that is most beneficial to their portfolio and shareholders.

Any new credit card issuance will likely be limited by more stringent underwriting. Again, driven by the need to reduce losses and expenses and due to the limitations the Act places on the ability of a credit card issuer to re-price risk as is done currently, card issuers will be stingier in their new issuance activity. That is probably good news if you hate all the credit card solicitation currently mass mailed to households across the US.

It is also widely expected that marketing and promotion budgets will be slashed in an effort to boost issuer profits. This includes rewards cards. It is widely expected that many of the most desirable benefits will be trimmed by many of the large issuers or will be limited to only the top credit scores.

While the Act has some strong benefits for cardholders, the Act will likely be a net negative for current cardholders who use their cards judiciously and pay their balances on time, in full each month. While these cardholders will likely not experience any of the negatives of a general rise in interest rates charged on the card (since they pay their balance monthly), these cardholders will likely see reduced cardholder benefits and the implementation of annual fees. These cardholders might even see their credit lines cut due the reduced spending activity seen across the economy due to the recession. The cardholders will not be rewarded for their responsible spending and prudence. Finally, these cardholders will probably see fewer promotions and less competition for their business. Ultimately, these borrowers will see the Act as a net negative.

At the same time, the prohibitions against marketing cards to college students without the means to repay is a strong positive in the Act. Further, there is some level of fairness within the Act that can make most cardholders (and Congressional voters) feel that the Act is a long-term net positive for the country.