Getting Tough?

  The Comptroller of the Currency has put card issuers on notice that they must clearly disclose penalty fees and risk-based pricing. But consumer advocates say the OCC is doing too little, too late.
  No practices in the card industry have incurred more wrath than penalty fees and risk-based pricing. Issuers say penalties such as late fees and higher interest rates are needed to offset any losses they might experience when high-risk cardholders go into default.
  But consumer-advocacy groups, lawmakers and regulators see it differently. Penalty fees and risk-based pricing, they say, are more about boosting profits than credit quality. And those that suffer most are the ones who can least afford it-low to middle-income consumers who live from paycheck to paycheck.
  One of the most controversial practices is so-called universal default. That's when an issuer raises a cardholder's annual percentage rate based on the cardholder's financial performance with another creditor. These penalty APRs can be as much as three or more times the beginning rate and eventually can add hundreds or even thousands of dollars to a cardholder's balance.
  Universal default has become an increasingly popular tool for issuers seeking to grow their bottom lines. Consumer Action, a San Francisco-based consumer-advocacy group, found that 44% of 45 issuers surveyed in 2004 had universal default policies. That compares with 39% in 2003.
  This most recent round in the debate over penalty fees and pricing has caught the attention of legislators, regulators and consumer groups:
  * Last July, U.S. Sen. Christopher J. Dodd, D-Conn., the senior Democrat on the Senate Banking Committee, introduced a bill calling for more disclosure about universal default. S. 2755, the Credit Card Accountability Responsibility and Disclosure Act of 2004, also would have required card issuers to disclose the length of time it would take a cardholder to pay off a balance if only the minimum payment is made.
  In addition, the bill would have required persons under 21 to prove they have the financial capacity to pay, or have a parent co-sign.
  The legislation contained disclosure requirements to "bring more transparency to an industry that has clearly reaped benefits from the use of fine print and lengthy and confusing policy statements," Dodd said when introducing the bill. The bill was referred to committee but didn't make much progress in the Republican-controlled 108th Congress. In mid-January, a spokesperson said Dodd plans to reintroduce the bill in the new 109th Congress.
  * In September, the U.S. Office of the Comptroller of the Currency issued an advisory letter expressing concern about three credit card marketing and account-management practices that may "entail unfair or deceptive acts" and may expose a bank to compliance risk or bad publicity. These included credit card solicitations that advertise credit limits "up to" a maximum dollar amount when that credit limit is seldom extended; using promotional rates without clearly disclosing significant restrictions on those rates; and increasing a cardholder's annual percentage rate or otherwise increasing a cardholder's cost of credit when the trigger for the increase has not been "disclosed fully or prominently."
  * San Diego-based Utility Consumers' Action Network (UCAN) in October sued Discover Financial Services Inc., challenging the card issuer's practice of raising cardholders' interest rates to as much as 24.99% based on late payments to other creditors. "In our review, we found that Discover card had the most abusive terms and conditions, which is why we chose to focus on it," UCAN Executive Director Michael Shames said in an e-mail message. He would not say whether UCAN would sue other issuers with universal default policies.
  A Discover spokesperson declined to comment on the suit, citing the company's policy against discussing pending litigation.
  UCAN is asking in San Diego Superior Court for an injunction ordering Discover to cease the practices and is seeking an unspecified amount of damages.
  Even the Public Broadcast System's Frontline documentary series and The New York Times weighed in on the penalty-fee issue, with a Nov. 23 program entitled, "Secret History of the Credit Card."
  This focus on alleged deceptive practices and penalty fees is not new. In 2000, the OCC and the San Francisco District Attorney ordered Providian Financial Corp. to pay $300 million in restitution after cardholders complained that the issuer didn't credit customer payments in a timely manner, charged for unauthorized services, and inadequately disclosed interest rates and fees.
  In that same year, irate consumers filed suit against Citibank and its AT&T Universal Card subsidiary and Metris Companies Inc., claiming the issuers delayed posting payments in order to trigger late fees and other penalties. In the Citibank/AT&T lawsuit, the issuer agreed to settle the lawsuit by paying $18 million to the affected cardholders.
  Though public outcry about penalty fees quieted down after the settlements, it never completely died out. All it took was issuers' ever-increasing use of penalty fees, including $39 late fees, and especially universal default, to bring the issue to the fore once again.
  Consumer complaints convinced the Office of the Comptroller of the Currency to issue the advisory letter because cardholders complained they were confused by cardholder agreements, particularly repricing strategies such as universal default.
  However, the advisory letter deals with disclosure of issuers' policies rather than the actual practice of universal default. "It's not that the repricing is unacceptable," an OCC spokesperson says, adding that the OCC requires banks to charge adequate interest rates for the risk presented by the consumer. "When the risk changes, we expect the banks to reassess the interest rate based on the risk profile of the consumer."
  What the OCC objects to is issuers not making clear under what circumstances a cardholder's interest rate could be increased. "Disclosures should be essentially clear and concise so that (a cardholder) knows 'OK, I agree to this credit card and if I have a hiccup somewhere in my other credit history, that could result in repricing,'" the spokesperson says. "Essentially, what we don't want is for these disclosures to be so obscure that they're on the last page of a 14-page document."
  Issuers that fail to comply with the OCC's advisory could face a number of supervisory actions, ranging from "saying 'hey, bank, you've got to do a better job''' to a formal enforcement action that could entail fines, the spokesperson says. "There's a whole realm (of supervisory choices) between those two extremes."
  But critics say the OCC is doing too little, too late.
  The advisory letter is "surprisingly weak," says Edmund Mierzwinski, consumer program director of the U.S. Public Interest Research Group, a Washington, D.C.-based consumer-advocacy group.
  Even when the banking regulator imposed the $300 million fine and other sanctions on Providian, it did so only after the San Francisco District Attorney "shamed it into taking reasonably strong actions" against the issuer, Mierzwinski says. The OCC hasn't taken such strong actions against a major issuer since then, he adds.
  Mierzwinski says that the OCC's letter falls short because it doesn't deal directly with universal default, a practice he calls "outrageous." Universal default is "solely being used by the industry to increase profit margins," he says. "They're gaming the system to figure out a way to squeeze more profits out of customers."
  When consumers apply for cards, issuers place them into a number of "risk buckets" offering rates ranging from "very good" to "predatory," Mierzwinski says. "They have sophisticated risk analysis for deciding what to charge you when you apply for a card, (but) they have a completely primitive system if you fail this ridiculous universal default test."
  When it comes to universal default, "if I miss one payment ... all of a sudden I jump from the head of the class to the back of the class. I go from being a perfect customer to a deadbeat with one missed payment. How come there is no in-between?" he says.
  Others share Mierzwinski's opinion.
  In its lawsuit, UCAN accuses Discover of "siphoning thousands of extra dollars from ... account holders in the form of bogus fees and improperly levied increased finance charges."
  The suit also charges that the policy constitutes an unlawful business act and practice in violation of California state law. And it challenges Discover's so-called Default Rate Plan that allows the issuer to boost an annual percentage rate to 19.99% if the cardholder pays late or exceeds the credit limit twice. Under the plan, Discover may raise the APR based on activity in the previous 11 billing cycles even though the provision was not in effect when the cardholder first accepted the card, the suit alleges.
  "To be clear, the contract in place at the time this unfortunate consumer chose to pay late or exceed her credit limit did not give Discover the right to increase her finance rates," the suit says.
  'Unlawful and Unfair'
  The fact that Discover could electronically decline a transaction, preventing the cardholder from exceeding her credit limit, exacerbates "this already unlawful and unfair practice," according to the suit. That gives Discover "an economic incentive to allow its cardholders to go over their limit so Discover can tack on over-the-limit fees and have an excuse to collect large amounts of additional finance charges," UCAN alleges in the suit.
  If Discover is concerned about a cardholder's credit risks, it could block new purchases or increase a cardholder's minimum payments, UCAN says.
  The argument that cardholders unhappy with Discover's practices can close the account "rings hollow," the lawsuit adds. "Once a customer has accrued a balance on a credit card, paying off that balance in a lump sum is burdensome for most customers and transferring that balance to another credit card company is not always feasible."
  With some issuers, universal default can kick in when there is a change in a cardholder's credit score, even if the change has nothing to do with credit risk, for example if a cardholder is the victim of identity theft, Mierzwinski says.
  An issuer's failure to report a cardholder's credit line also can lower a consumer's credit score. The Federal Reserve recently reported that 33% of consumers have at least one account for which their issuers do not report credit limits.
  Further, the credit-bureau data used to calculate credit scores often are flawed. A June 2004 study by U.S. PIRG found that 25% of credit reports contained errors serious enough to result in denial of credit.
  But issuers say universal default is meant to prevent a problem that emerged more than a decade ago-cardholders with good payment performance filing for bankruptcy without warning.
  "You have somebody who paid their credit card on time, and they were borrowing slowly but surely more, but they were on time," Edward Yingling, incoming president of the American Bankers Association, told Frontline. "They looked really good, right up to the day they declared bankruptcy and had nothing, and you lost everything you'd lent them."
  Despite the public outcry, card issuers aren't likely to abandon methods that cut losses and maximize revenues. And consumers most certainly will continue to rail against tactics they consider exploitive. That means the uproar over universal default and other account-management and marketing practices won't die down anytime soon.