June 2005 Legal Briefs

Consumer Loan Dollar Amounts Adjusting on July 1

a. Increased Late Fees 
b. “508B” and “508A” Loans 
c. Dealer Paper “No Deficiency” Amount 

Regulation DD’s Amendments Cover Overdraft Plans

1. Background
2. Expanded Emphasis of Disclosures
3. Advertising “Free” Accounts
4. General Advertising Requirements
5. Misleading or Inaccurate Advertising
6. Revised Truth-in-Savings Disclosures
7. Periodic Statement Disclosures
8. Itemizing Fees by Type

Consumer Loan Dollar Amounts Adjusting on July 1

As of July 1 each year, the Consumer Credit Administrator can adjust for inflation certain dollar amounts found in various sections of Oklahoma’s Uniform Consumer Credit Code (U3C).  The most recent change in dollar amounts was as of July 1, 2003.  (No change was made at July 1, 2004, due to very low inflation.)

The Administrator recently announced new U3C dollar amounts (set out in a chart at the end of this article) that take effect on July 1, 2005.  (Most amounts have increased by approximately 5%, compared to amounts established two years ago.)

a.  Increased Late Fees.  The fee that banks ask about most is the maximum late fee for consumer loans and dealer paper.  As you are probably aware, the maximum permitted late fee has been the greater of $19.00 or 5% of the past-due payment. This formula changes on July 1 to the greater of $20.00 or 5% of the past-due payment.  

Before a bank can charge any late fee, the consumer must agree to it in writing.  If a loan is originated, deferred or renewed on or after July 1, the signing of documents is an opportunity to get the borrower to consent in writing to the new $20.00 portion of the late-fee formula.  However, for any loan that is already outstanding and not being modified or renewed, a bank has no good way to increase the amount of late fee that the consumer has previously agreed to pay.  

Some banks have specifically pegged the “dollar amount” portion of their late fee formula at $19.00 (or lower amounts in earlier years)–so for existing loans there may be no way to raise the late fee at July 1.  Other banks have used an adjustable formula in the late-fee provision of their loans, allowing for the greater of 5% of the late payment or the maximum dollar amount established by rule of the Consumer Credit Administrator from time to time.  (Banks using a formula that specifically allows for this type of inflation adjustment can now re-set their existing loans to charge the new, higher late fee as of July 1.)  

b.  “508B” and “508A” Loans.  Some banks make small consumer loans based on a special finance-charge method that combines an initial “acquisition charge” with monthly “installment account handling charges,” and does not have a stated annual interest rate.  The requirements for such loans are outlined in Section 3-508B of the U3C.

The maximum permitted principal amount for one of the small loans just mentioned has been $760.00, but now is adjusting to $800.00.  The specific fees chargeable on one of these loans depend on where the loan falls within certain dollar brackets stated in the statute.  Both the dollar brackets and the fees chargeable within each bracket are adjustable for inflation, and the revised amounts as of July 1 are set out in more detail in the chart at the end of this article.

The chart that banks use for determining the “maximum rate of interest” allowable on small loans calculated by the other available finance charge method (under Section 3-508A) will also change somewhat because of adjustments for inflation at July 1.   The maximum consumer-loan dollar amount on which a blended interest rate higher than 21% can be charged by the 3-508A method will increase from $3,800 to $4,000.

c. Dealer Paper “No Deficiency” Amount.  Based on Section 5-103(2) of the U3C, if dealer paper is secured by goods having an original cash price less than a certain dollar amount, and those goods are later repossessed or surrendered, the creditor cannot obtain a deficiency judgment when the collateral sells for less than the balance outstanding.  This dollar amount was previously $3,700, and increases to $3,800 on July 1. 

Regulation DD’s Amendments Cover Overdraft Plans

If a bank advertises its overdraft services to consumers, or notifies consumers that they have an overdraft limit available, new Regulation DD disclosure requirements will apply, beginning July 1, 2006.  (A bank with a more traditional overdraft program, establishing an internal overdraft limit for consumers but not notifying consumers of that fact nor actively promoting the bank’s overdraft services, will have few new requirements.)

There are three areas of change for banks currently advertising or announcing overdraft services: (1) the contents of account-opening (Truth-in-Savings) disclosures; (2) the contents of bank advertisements, brochures, or notifications to customers concerning overdraft plans; and (3) the method of disclosing overdraft fees on monthly account statements.

The biggest challenge from a compliance standpoint (for overdraft plans that are advertised or announced to customers) may be in re-formatting monthly account statements so that they will separately list, as required, (1) the total fees or charges for paying items into overdraft that month, (2) the cumulative total of overdraft fees year-to-date, (3) the total fees or charges for returning items unpaid that month, and (4) the cumulative total of returned-item fees year-to-date.

The disclosed monthly and year-to-date totals of overdraft charges must add together not only any per-item overdraft fees, but also any related daily fees or interest resulting from an overdrawn balance.  Returned-item fees (if any) must be broken out separately from overdraft charges so that the consumer can see the precise cost of using the overdraft plan by itself.

The major issue for banks is that their data processing systems will need to be changed to calculate and print the monthly and year-to-date total overdraft fees in the format that the revised regulation requires.  Depending on a bank’s particular system, the required modifications may not be easy to accomplish.   

By July 1, 2006, all banks either (1) must have an appropriately revised system for summarizing fees on monthly statements, or else (2) must stop promoting overdrafts and notifying their customers concerning overdraft protection until the bank can set up an appropriate periodic-statement disclosure system.

Although July 1, 2006, seems a long way off, a bank needs to start working out its compliance strategy.  For example, if a bank would have to print more Truth-in-Savings disclosures and/or more overdraft protection brochures anyway, at some time during the next thirteen months, that bank should use the opportunity to switch to revised disclosures.  (Early compliance is allowed, on an optional basis.)  Planning ahead will avoid having a large stock of materials that cannot be used after July 1, 2006.

I will discuss the various changes to Reg DD and the related Commentary in more detail below.

1.  Background

Overdraft services have been fairly unregulated in the past, but that is rapidly changing.  First, in February 2005, the Federal banking regulators issued joint guidance on overdraft protection plans, classifying such arrangements as “credit,” and pointing out steps a bank must take to comply with various Federal statutes.  They also outlined a list of “best practices” a bank should consider following.  (See my March article on this subject.)

Now, as a second step, the Federal Reserve has amended its Regulation DD disclosure requirements to clarify what deposit-account-related disclosures are required if overdraft services are actively marketed as a feature of deposit accounts.  

Public comments on the current round of changes to Regulation DD suggested that overdraft protection plans should become subject to Regulation Z disclosures.  The Fed has again considered, but rejected, this particular approach.  Still, the Fed warns that is would have authority to amend Reg Z in the future to cover overdrafts.

The Fed has always excluded overdrafts from Reg Z’s coverage—as long as a bank did not grant an “overdraft line of credit” or otherwise promise in writing to pay the items.  Historically, overdrafts were infrequent, and often were approved only case-by-case, as a courtesy.  A bank’s internal overdraft limit (if any) was not announced to consumers, who certainly were never actively encouraged to write overdrafts.  On this basis, exempting overdrafts from regulations seemed appropriate to everyone and caused no problems.

In recent years, the Fed has become increasingly concerned about overdraft plans that are actively marketed as a feature of deposit accounts.  Some banks have not provided the same clear disclosures for overdraft protection that Reg DD requires them to provide for other standard features of deposit accounts.  

A further problem in disclosing the terms of an overdraft program clearly is the fact that the consumer usually can’t be sure exactly what the overall cost of writing an overdraft check will be–because he can’t anticipate how many separate per-item overdraft fees will be imposed when his balance becomes negative.  For example, if a person has a lot of small checks outstanding that can be paid from his available balance, and then he writes one $150 check that would overdraw his balance, he may think he’s going to have one overdraft charge.  But if the $150 check is presented and paid before the small checks, or if all the checks are presented on the same day and the bank’s policy is to pay checks “large to small,” the consumer could have a lot of separate overdraft fees just because he wanted to overdraw his balance with one $150 check.  

When overdraft services are not actively promoted by the bank, multiple overdraft fees can still occur, but not as much.  If overdrafts are actively encouraged, multiple overdraft fees are a more frequent event, and the consumer’s misunderstanding of fees can turn into a bigger issue.    

Originally, the Fed considered imposing enhanced Truth-in-Savings disclosures on all accounts that pay overdrafts.  However, the Fed decided not to place increased compliance burdens on banks that do not actively market their overdraft services and do not notify customers of any available overdraft limit.  

Accordingly, the new Regulation DD revisions are directed at banks that actively announce or market an overdraft plan.  These banks are the ones with the highest level of overdraft activity, and their customers are the ones most needing any applicable disclosures.

(A bank wanting to avoid the new Reg DD disclosures can stop advertising overdraft services by July 1, 2006, while also avoiding actively notifying customers of their available overdraft limit on or after that date.  It is not necessary for a bank to actually terminate its existing overdraft program to avoid the changes, if it stops its marketing and notification efforts before the effective date of the amended regulation.  Of course, most banks will want to continue marketing their overdraft plan, and will comply with the new requirements.)

2.  Expanded Emphasis of Disclosures

Regulation DD’s coverage has previously included (1) required disclosures of certain terms at the time of opening an account; (2) subsequent disclosures (but usually only if a term required to be disclosed at account opening is later changed in a manner adverse to the customer); (3) periodic-statement disclosures, for limited items, and (4) advertising, but generally only with respect to terms for opening an account, and not concerning an announcement of features being added to an existing account.

Until now, the Reg DD impact of adding an overdraft plan to an existing account has been (1) charging an overdraft fee in an amount that probably was already properly disclosed when the account was opened; (2) no “adverse change” in terms, and therefore no “subsequent disclosure” when the overdraft plan is added, unless the per-item overdraft fee is increasing, (3) no change in periodic statement disclosures, other than meeting the already-existing requirement to list the overdraft charges on the statement as they are incurred, and (4) no required impact on “advertising,” which terminology previously did not include communications with consumers about existing accounts.   

The Fed was uncomfortable with this “status quo” because (1) overdraft plans are usually added to an account based on no application or request by the consumer, (2) very little information needs to be given at such time, based on Reg DD’s existing requirements, (3) considerable fees can be imposed, and damage can be done to the consumer’s credit, if he does not understand how overdraft fees are charged and posted or when overdraft balances must be cleared, and (4) the existing “misleading or inaccurate” advertising standard in Reg DD leaves too much grey area with regard to overdraft services, without specific examples being given.   

Accordingly, the Fed’s Reg DD revisions require more extensive overdraft-related account disclosures, as well as clearer advertising and more specific fee information on monthly statements.  

The definition of “advertisement” in Section 230.2(b) has been expanded to include certain communications with consumers concerning the terms of existing accounts—such as a notice to consumers that they will have an overdraft limit available, and that overdrafts will be handled in a certain way.

3.  Advertising “Free” Accounts

Until now, banks have been able to advertise “totally free checking with overdraft protection,” with no additional wording.  All “free” accounts impose overdraft charges; but (unlike maintenance or activity fees, which are prohibited) an overdraft fee has been allowed, and virtually disregarded, as a charge on such accounts.  It’s not contradictory to call an account “free,” although overdraft charges apply, if you view the overdraft charge as “avoidable” by the consumer!  (However, the financial reality can be quite different from this “theoretical” analysis:  Banks often make quite a bit of income from overdraft charges on “free” accounts.)  Still, an overdraft fee is not really imposed with respect to ordinary operation of the account itself, or the consumer’s money in the account, but instead arises from the consumer’s absence of money and the bank’s courtesy in extending credit to cover the deficit.

When overdraft services are marketed as a valuable feature of an account, banks are potentially encouraging consumers to incur overdraft fees on a regular basis.   The more actively a bank’s overdraft services are promoted, the more confusing it may be to the consumer if the account is described as “free.”

Revised Section 230.8(a)(10) of the Fed’s Commentary to Regulation DD (effective July 1, 2006) helps to resolve some of the “free” account problems by giving examples of advertisements “that would ordinarily be misleading, inaccurate, or misrepresent the deposit contract.” Among these is example (10)(v), which prohibits advertising any account-related service for which the bank charges a fee, in the same advertisement that uses the word “free” or “no cost” to describe the account, unless the advertisement also “clearly and conspicuously” indicates that there is a cost associated with the added service.  

For example, to obtain an optional debit card in connection with a “free” account, the consumer might have to pay a one-time $2.00 fee.  Similarly, on-line bill-pay may be available as an optional feature, at a per-transaction cost, although the basic “free” account does not include this feature.  

Under the revised provision, an advertisement (such as a billboard) cannot state, “Free checking. Debit card and on-line bill-payment also available.”  Instead (if true), the ad will have to say, “Free checking. Debit card and on-line bill-pay available at additional cost.”   (The “clearly and conspicuously” requirement probably would not allow a bank to put the phrase “at additional cost” in significantly smaller type or in a footnote.)

4.  General Advertising Requirements

The Commentary to new Section 230.11(a) gives examples of what the Fed means by “advertising the payment of overdrafts.”  This covers (as you might expect) radio, TV, and print ads; brochures; telephone solicitations; e-mails; internet sites; billboards; and indoor signs.  Going much further, however, “advertising” of overdrafts will also include messages on ATM screens or receipts; messages on periodic statements informing the consumer of an overdraft limit or the amount of funds available for overdrafts; disclosure of the consumer’s overdraft limit by any means (including by letter or ATM receipt), except for information given by in-person discussions; and including an overdraft limit within an available balance amount disclosed to the consumer, such as on an ATM receipt, on a telephone response menu-option system, on an ATM screen, or by consumer access to the  account through internet banking.  

Unless the bank has only an informal, traditional overdraft system such as banks maintained years ago (not emphasizing the existence of an overdraft program and not disclosing any internal overdraft limit to the consumer), a bank probably is “advertising” overdraft services, and probably does have to make new disclosures.

At new Section 230.11(b)(1), revised Regulation DD includes four separate disclosure requirements that must be included in anything the regulation defines as an “advertisement” of overdraft services.

Except for specific cases listed in new Section 230.11(b)(2), (3) and (4)—such as billboard advertising, indoor signs (if certain wording is used), television or radio ads, ATM screens, and in-person discussions with consumers, all of which may require brevity—the following four requirements will apply to most other situations involving an ordinary advertisement, brochure, statement stuffer or letter of notification that promotes overdraft services:

(1) The bank must clearly disclose the fee(s) for payment of each overdraft.  This may require disclosing not only the per-item overdraft fee but also any daily fees or interest charges that apply while the account has a continuing negative balance.

(2) The bank must disclose the categories of transactions for which an overdraft fee may be imposed.  In particular, the Fed is concerned that describing the service as “overdraft checking” or “protection against bounced checks” may not adequately alert the customer (if true) that the overdraft program (and overdraft fees) will also apply when a negative balance results from ATM transactions, teller transactions, ACH items, on-line transfers, etc.

The revised Commentary says it’s not necessary to give an exhaustive list of every type of transaction that can result in a negative balance and an overdraft fee.  Model language allows a bank simply to state that a fee may be imposed for covering overdrafts that are “created by check, in-person withdrawal, ATM withdrawal, or other electronic means.”  (Types of transactions not available on the account or not subject to overdraft fees should be omitted from this description.)

(3) The bank has to disclose the time period by which the consumer must repay or cover an overdraft.  (Encouraging a consumer to overdraw his account without stating the maximum time period for repayment would leave out important information required for decision-making.)  The point is to warn consumers in one way or another that they are expected to cover an overdraft in a relatively short period of time.  According to the Commentary, if a bank prefers to simply state that it reserves the right to require a consumer to pay an overdraft immediately or on demand, that’s enough.

(4) The bank must also disclose the circumstances under which it will not pay an overdraft.  A bank can list the various situations, or it can use the following model language:  “Whether your overdrafts will be paid is discretionary and we reserve the right not to pay.  For example, we typically do not pay overdrafts if your account is not in good standing, or you are not making regular deposits, or you have too many overdrafts.”

The regulation does allow the following types of communication with consumers (not considered to be “advertising”) without triggering the special Reg DD disclosure requirements listed above:

(a) Advertising a formal overdraft line of credit, where the bank agrees in advance to pay overdrafts and disclosures are given under Regulation Z;

(b) Communicating with the consumer (by telephone, electronically, or otherwise) concerning the payment of overdrafts, in response to a consumer-initiated inquiry (but not including providing recorded or pre-programmed information about overdraft services in response to a consumer inquiry made through telephone, ATM, or internet-site contact with the bank);

(c) Engaging in any in-person discussion with a consumer (including verbally describing overdraft services, but not including providing material
that itself would be defined as “advertising”);

(d) Making disclosures that are required by federal or other applicable laws–such as providing a Truth-in-Savings disclosure statement listing the amount of the bank’s overdraft charges (but this exemption does not apply if the bank mixes promotional material with required disclosures);

(e) Providing a notice or statement information about a specific overdrawn item or the consumer’s overdrawn balance;

(f) Providing notice, such as at an ATM, that completing a requested transaction may trigger an overdraft fee; or

(g) Providing general information concerning payment of overdrafts, if the information is not specific to the bank’s own overdraft service.

5.  Misleading or Inaccurate Advertising

The regulation already prohibits “misleading or inaccurate advertising,” in Section 230.8(a).  Revisions to the Commentary add some specific examples of what will be considered “misleading or inaccurate” in advertising overdraft services (including overdraft services that are added to an existing account):

(1) Representing that an overdraft service is a “line of credit” (unless the bank has promised in writing to pay overdrafts and those overdrafts are subject to Regulation Z disclosures);

(2) Representing that the bank will honor all checks or authorize payment of all transactions within an overdraft limit, when in fact (to avoid Regulation Z) the bank reserves the right not to honor checks or to authorize transactions;

(3) Representing that consumers are allowed to maintain a negative balance in their account, although in fact the terms of the overdraft services require the consumer promptly to return the deposit account to a positive balance;

(4) Describing the bank’s overdraft services only as a protection against bounced checks, when in fact overdrafts (resulting in an overdraft fee) are also allowed (as applicable) by such means as in-person withdrawals, ATM withdrawals, debit card transactions, ACH debits, on-line payment, and transfers between accounts; or

(5) Advertising any additional (optional) account-related service (not just overdraft services) in an advertisement that uses the word “free” or “no cost,” without clearly and conspicuously indicating that there is a cost associated with the additional account-related service.

6. Revised Truth-in-Savings Disclosures

Generally, the regulation’s changes do not affect required account-opening disclosures if a bank is not promoting its overdraft services.  One exception applies—how a bank’s overdraft fee must be described.  

Existing Section 230.4(b)(4) of Regulation DD requires a bank to disclose “the amount of any fee that may be imposed,” and “the conditions under which the fee may be imposed.”  Based on a newly added provision of the Fed’s Commentary to this same section, it will not be adequate to describe a fee as  being an “overdraft fee” or “for overdraft items.”  Instead, a bank will be required to provide greater detail, specifying the categories of transactions for which an overdraft fee may be imposed. An exhaustive list of possible transactions is not necessary. Using model language, it will be sufficient to state that the fee applies to overdrafts “created by check, in-person withdrawal, ATM withdrawal, or other electronic means,” as applicable.

The Fed advises that a bank will not be required to make any Truth-in-Savings re-disclosures to existing customers because of this change, if the original disclosure given to a consumer was in compliance with Regulation DD at the time.  (This applies to all disclosures given up to July 1, 2006—the effective date of the change.)  However, the Fed says a bank should “consider” whether it wants to go back to existing customers to clarify that overdraft charges are not just for checks but may also apply to in-person withdrawals, ATM withdrawals, and other electronic transactions, as applicable.

7. Periodic Statement Disclosures

New Section 230.11(a) lists additional information required to be disclosed on periodic statements if banks are advertising the payment of overdrafts:

A bank must disclose on each monthly statement (1) the aggregate (total) dollar amount of all fees or charges imposed on the account during the period for paying overdrafts, or imposed because of overdrawn balances; and (separately) (2) the aggregate (total) dollar amount of all fees imposed on the account during the period for returning items unpaid.  A periodic statement actually must disclose each of these totals both (a) for the current statement period, and (b) on a cumulative basis, combining all months year-to-date.

A monthly statement for an account with a lot of such activity might contain a disclosure something like the following:

“Overdraft fees & charges for the period: $150.00; Overdraft fees & charges year-to date: $485.00; Returned check charges for the period:  $50.00; Returned check charges year-to-date: $175.00.”

Although the example just given may look extreme, it is definitely the Fed’s intention to highlight the total cost dramatically so that a consumer may be motivated to manage his account better, and/or so he may consider whether a different product, such as a small loan, would better suit his needs.

As I suggested earlier, banks will need to modify their data processing systems before they can automatically calculate these overdraft-fee totals and returned-check-fee totals and make proper disclosures on periodic statements.

If a bank’s communications do not specify what categories of account its “advertised” overdraft plan applies to, the above disclosures will have to be given for all types of accounts—even if no charge is actually imposed on a particular account during the current statement period or year-to-date.

The requirement to make total-fee disclosures on statements will begin with the periodic statement for the first statement period that starts after the bank advertises overdraft services.   (Because of the regulation’s effective date, this actually means the date of first advertisement occurring on or after July 1, 2006.)  If the bank is already advertising overdrafts before July 1, 2006, and continues doing so, its first advertisement under the revised regulation will be treated as occurring on July 1, 2006.  

For example, if an account’s monthly statements are prepared on the 15th day of each month, there would be no periodic disclosure requirement for the period that begins on June 16, 2006 (prior to July 1) and ends July 15, 2006.  Rather, in this example, the disclosures apply to the first full statement period beginning after the July 1, 2006 date, which would mean the statement period running from July 16, 2006 through August 15, 2006.

When a bank’s first advertisement of overdraft services would occur at some point after the beginning of a year, the required “year-to-date” disclosure of overdraft charges and returned-check charges is satisfied by adding together twelve consecutive calendar months of activity, beginning with the first monthly statement on which the disclosures are required to be made.  In the example given earlier, the twelve-month “year-to-date” period would start with the August 15, 2006 statement and continue through the July 15, 2007 statement.  

 If a bank “advertises” its overdraft services on or after July 1, 2006, it will not be allowed to stop making required periodic-statement disclosures on the account to which those services apply, until two full years after the bank’s last “advertisement” promoting overdraft services occurs.  (However, if a bank stops advertising overdraft services before the July 1, 2006, effective date of the revised provisions, the disclosure requirement for periodic statements will never go into effect, and there will be no two-year period before disclosures can stop.)

8.  Itemizing Fees by Type

Under existing Section 230.6, fees required to be disclosed on periodic statements must be itemized by type and dollar amounts.  As a clarification of this requirement, if fees of the same type are imposed more than once in a statement period, revised language will allow the bank either to itemize each fee event separately or to disclose a combined total dollar amount for all fees of that same type during that period.  

An exception in Section 230.6 to this new “either way” disclosure rule will apply to overdraft-related fees—and it specifically cross–references the more specific requirements on that subject in new Section 230.11(a)(1).  If a bank “advertises” its overdraft services, the overdraft-related charges for the current period (and year-to-date) must be disclosed on the statement as totals–whether or not these charges are also listed on the statement as individual line-items—and, in addition, all returned-check charges for the current period (and year to date) must be disclosed in a separate combined total, regardless of whether these fees are also listed individually for each specific transaction.

The Commentary to new Section 230.11(a) provides some additional guidance.  If fees included in a total on a statement represent more than a single fee, the description must so indicate, such as “total fees (plural) for [X].”  

The revised Commentary also states that certain types of fees cannot be combined into a single total on a periodic statement:

(1) Excess-activity fees cannot be combined with monthly maintenance fees.

(2) “Per-item” transfer fees (between accounts) cannot be combined if they are in different dollar amounts—for example, if there is a charge of $0.50 for money transferred in, but $1.00 for money transferred out.

(3) Fees for electronic fund transfers cannot be combined with other service fees, such as maintenance fees or balance-inquiry fees.

(4) Fees for paying overdrafts (including fees for paying items when deposited funds are not yet available) cannot be combined with fees for returning items unpaid.