**Office of the Comptroller of the Currency**

**Board of Governors of the Federal Reserve System**

**Federal Deposit Insurance Corporation**

**Office of Thrift Supervision**

  ----------------------------------- -----------------------------------
  *Subject: **Credit Card Lending***  *Description: **Account Management
                                      and Loss Allowance Guidance***

  ----------------------------------- -----------------------------------

## Purpose

Recent examinations of institutions engaging in credit card lending have
disclosed a wide variety of account management, risk management, and
loss allowance practices, a number of which were deemed inappropriate.
This interagency guidance communicates the Agencies' expectations for
prudent practices in these areas.

The Agencies recognize that some institutions may require time to
implement changes in policies, practices, and systems in order to
achieve full consistency with the guidance on credit card account
management. Such institutions should work with their primary federal
regulator to ensure implementation of needed changes as promptly as
possible.

With respect to income recognition and loss allowance practices for
credit card lending, the guidance reflects generally accepted accounting
principles (GAAP), existing interagency policies on loss allowances, and
current Call Report and Thrift Financial Report instructions.[^1] The
Agencies expect continued and ongoing compliance with GAAP and these
reporting instructions.

**Contents**

Purpose [1](#purpose)

Applicability of Guidance [2](#applicability-of-guidance)

Account Management, Risk Management, and Loss Allowance Practices
[2](#account-management-risk-management-and-loss-allowance-practices)

Credit Line Management [2](#credit-line-management)

Over-limit Practices [3](#over-limit-practices)

Minimum Payment and Negative Amortization
[3](#minimum-payment-and-negative-amortization)

Workout and Forbearance Practices
[4](#workout-and-forbearance-practices)

Income Recognition and Loss Allowance Practices
[5](#income-recognition-and-loss-allowance-practices)

Policy Exceptions [6](#policy-exceptions)

## Applicability of Guidance

The account management and loss allowance principles described herein
are generally applicable to all institutions under the Agencies'
supervision that offer credit card programs. The risk profile of the
institution, the strength of internal controls (including internal audit
and risk management), the quality of management reporting, and the
adequacy of charge-off policies and loss allowance methodologies will be
factored into the Agencies' assessment of the overall adequacy of these
account management practices. Regulatory scrutiny and risk management
expectations for certain practices, such as negative amortization of
over-limit accounts, will be greater for higher risk portfolios and
portfolio segments, including those that are subprime.

Wherever such practices are deemed inadequate or imprudent, regulators
will require immediate corrective action.

## Account Management, Risk Management, and Loss Allowance Practices

The Agencies expect institutions to fully test, analyze, and support
their account management practices, including credit line management and
pricing criteria, for prudence prior to broad implementation of those
practices. Credit card lenders should review their practices and
initiate changes where appropriate.

#### Credit Line Management

When assigning initial credit lines and/or significantly increasing
existing credit lines, lenders should carefully consider the repayment
capacity of borrowers. When inadequately analyzed and managed, practices
such as multiple card strategies and liberal line-increase programs can
increase the risk profile of a borrower quickly and result in rapid and
significant portfolio deterioration.

Credit line assignments should be managed conservatively using proven
credit criteria. The Agencies expect institutions to test, analyze, and
document line-assignment and line-increase criteria prior to broad
implementation. Support for credit line management should include
documentation and analysis of decision factors such as repayment
history, risk scores, behavior scores, or other relevant criteria.

Institutions can significantly increase credit exposure by offering
customers additional cards, including store-specific private label cards
and affinity relationship cards, without considering the entire
relationship. In extreme cases, some institutions have granted
additional cards to borrowers already experiencing payment problems on
existing cards. The Agencies expect institutions that offer multiple
credit lines to have sufficient internal controls and management
information systems (MIS) to aggregate related exposures and analyze
performance prior to offering additional credit lines.

#### 

#### Over-limit Practices

Account management practices that do not adequately control
authorization and provide for timely repayment of over-limit amounts may
significantly increase the credit risk profile of the portfolio. While
prudent over-limit practices are important for all credit card accounts,
they are especially important for subprime accounts, where liberal
over-limit tolerances and inadequate repayment requirements can magnify
the high risk exposure to the lending institution, and deficient
reporting and loss allowance methodologies can understate the credit
risk.

Over-limit practices at all institutions should be carefully managed and
should focus on reasonable control and timely repayment of amounts that
exceed established credit limits. Management information systems for all
institutions should be sufficient to enable management to identify,
measure, manage, and control the unique risks associated with over-limit
accounts. Over-limit authorization on open-end accounts, particularly
those that are subprime, should be restricted and subject to appropriate
policies and controls. The objective should be to ensure that the
borrower remains within prudent established credit limits that increase
the likelihood of responsible credit management.

#### Minimum Payment and Negative Amortization

Competitive pressures and a desire to preserve outstanding balances have
led to a general easing of minimum payment requirements in recent years.
New formulas that have the effect of further delaying principal
repayment are gaining popularity in the industry. In many instances, the
result has been liberal repayment programs that increase credit risk and
mask portfolio quality. These problems are exacerbated when minimum
payments consistently fall short of covering all finance charges and
fees assessed during the billing cycle and the outstanding balance
continues to build ("negative amortization"). In these cases, the lender
is recording uncollected income by capitalizing the unpaid finance
charges and fees into the account balance owed by the customer. The
pitfalls of negative amortization are magnified when subprime accounts
are involved, and even more so when the condition is prolonged by
programmatic, recurring over-limit fees and other charges that are
primarily intended to increase recorded income for the lender rather
than enhance the borrowers' performance or their access to credit.

The Agencies expect lenders to require minimum payments that will
amortize the current balance over a reasonable period of time,
consistent with the unsecured, consumer-oriented nature of the
underlying debt and the borrower's documented creditworthiness.
Prolonged negative amortization, inappropriate fees, and other practices
that inordinately compound or protract consumer debt and disguise
portfolio performance and quality raise safety and soundness concerns
and are subject to examiner criticism.

#### Workout and Forbearance Practices

Institutions should properly manage workout[^2] programs. Areas of
concern involve liberal repayment terms with extended amortizations,
high charge-off rates, moving accounts from one workout program to
another, multiple re-agings, and poor MIS to monitor program
performance. Where workout programs are not managed properly, the
Agencies will criticize management and require appropriate corrective
action. Such actions may include adversely classifying entire segments
of portfolios, placing loans on nonaccrual, increasing loss allowances
to adequate levels, and accelerating charge-offs to appropriate time
frames.

Temporary hardship programs that help borrowers overcome temporary
financial difficulties are not considered workout programs for this
guidance. Temporary hardship programs longer than a 12-month duration,
including renewals, are considered workout programs.

**Repayment Period** ‑ Repayment terms for accounts in workout programs
vary widely among credit card issuers. Practices range from programs
designed to maximize collection of balances owed to programs apparently
designed to maximize income recognition and defer losses. Some
institutions' programs have not reduced interest rates sufficiently to
facilitate timely repayment and assist borrowers in extinguishing
indebtedness. In many cases, reduced minimum payment requirements in
combination with continued charging of fees and finance charges have
extended repayment periods well beyond reasonable time frames.

Workout programs should be designed to maximize principal reduction.
Workout programs should generally strive to have borrowers repay credit
card debt within 60 months. Repayment terms for workout programs should
be consistent with these time frames, with exceptions clearly documented
and supported by compelling evidence that less conservative terms and
conditions are warranted. To meet these time frames, institutions may
need to substantially reduce or eliminate interest rates and fees so
that more of the payment is applied to reduce principal.

**Settlements** ‑ Institutions sometimes negotiate settlement agreements
with borrowers who are unable to service their unsecured open-end
credit. In a settlement arrangement, the institution forgives a portion
of the amount owed. In exchange, the borrower agrees to pay the
remaining balance either in a lump-sum payment or by amortizing the
balance over a several month period. Institutions' charge-off practices
vary widely with regard to settlements.

Institutions should ensure that they establish and maintain adequate
loss allowances for credit card accounts subject to settlement
arrangements. In addition, the FFIEC Uniform Retail Credit
Classification and Account Management Policy states that \"actual credit
losses on individual retail loans should be recorded when the
institution becomes aware of the loss." In general, the amount of debt
forgiven in a settlement arrangement should be classified loss and
charged off immediately. However, a number of issues may make immediate
charge-off impractical. In such cases, institutions may treat amounts
forgiven in settlement arrangements as specific allowances.[^3] Upon
receipt of the final settlement payment, deficiency balances should be
charged off within 30 days.

#### Income Recognition and Loss Allowance Practices

Most institutions use historical net charge-off rates, based on
migration analysis of the roll rates[^4] to charge-off, as the starting
point for determining appropriate loss allowances. Institutions then
typically adjust the historical charge-offs for current trends and
conditions and other factors. Recent examinations of credit card lenders
have revealed a variety of income recognition and loss allowance
practices. Such practices have resulted in inconsistent estimates of
incurred losses and, accordingly, the inconsistent reporting of loss
allowances.

**Accrued Interest and Fees**[^5] ‑ Institutions should evaluate the
collectibility of accrued interest and fees on credit card accounts
because a portion of accrued interest and fees is generally not
collectible. Although regulatory reporting instructions do not require
consumer credit card loans to be placed on nonaccrual based on
delinquency status, the Agencies expect all institutions to employ
appropriate methods to ensure that income is accurately measured. Such
methods may include providing loss allowances for uncollectible fees and
finance charges or placing delinquent and impaired receivables on
nonaccrual status. Institutions must account for the owned portion of
accrued interest and fees, including related estimated losses,
separately from the retained interest in accrued interest and fees from
credit card receivables that have been securitized.

**Loan Loss Allowances** ‑ The allowance for loan and lease losses
(ALLL) should be adequate to absorb credit losses that are probable and
estimable on all loans. While some institutions provide for an ALLL on
all loans, others only provide for an ALLL on loans that are delinquent.
Typically, this practice results in an inadequate ALLL. Institutions
should ensure that their loan impairment analysis and ALLL methodology,
including the analysis of roll rates, consider the loss inherent in both
delinquent and non-delinquent loans.

**Allowances for Over-limit Accounts** ‑ Institutions' allowance
methodologies do not always fully recognize the loss inherent in
over-limit portfolio segments. For example, if borrowers were required
to pay over-limit and other fees, in addition to the minimum monthly
payment amount each month, roll rates and estimated losses may be higher
than indicated in the overall portfolio migration analysis. Accordingly,
institutions should ensure that their allowance methodology addresses
the incremental losses that may be inherent on over-limit accounts.

**Allowances for Workout Programs** ‑ Some institutions' allowances do
not appropriately provide for the inherent probable loss in workout
programs, particularly where repayment periods are liberal with little
progress on reducing principal. The success of workout programs varies
widely by program and among institutions.

Accounts in workout programs should be segregated for performance
measurement, impairment analysis, and monitoring purposes. Where
multiple workout programs with different performance characteristics
exist, each program should be tracked separately. Adequate allowances
should be established and maintained for each program. Generally, the
allowance allocation should equal the estimated loss in each program
based on historical experience as adjusted for current conditions and
trends. These adjustments should take into account changes in economic
conditions, volume and mix, terms and conditions of each program, and
collections.

**Recovery Practices** ‑ After a loan is charged off, institutions must
properly report any subsequent collections on the loan.[^6] Typically,
some or all of such collections are reported as recoveries to the
allowance for loan and lease losses. Recent examinations have revealed
that, in some instances, the total amount credited to the ALLL as
recoveries on an individual loan (which may have included principal,
interest, and fees) exceeded the amount previously charged off against
the ALLL on that loan (which may have been limited to principal). Such a
practice understates an institution's net charge-off experience, which
is an important indicator of the credit quality and performance of an
institution's portfolio.

Consistent with regulatory reporting instructions and prevalent industry
practice, recoveries represent collections on amounts that were
previously charged off against the ALLL. Accordingly, institutions must
ensure that the total amount credited to the ALLL as recoveries on a
loan (which may include amounts representing principal, interest, and
fees) is limited to the amount previously charged off against the ALLL
on that loan. Any amounts collected in excess of this limit should be
recognized as income.

#### Policy Exceptions

The Agencies recognize that in well-managed programs limited exceptions
to the FFIEC Uniform Retail Credit Classification and Account Management
Policy may be warranted. The basis for granting exceptions to the Policy
should be identified and described in the institution\'s policies and
procedures. Such policies and procedures should address the types of
exceptions allowed and the circumstances for permitting them. The volume
of accounts granted exceptions should be small and well controlled, and
the performance of accounts granted exceptions should be closely
monitored. Examiners will evaluate whether an institution uses
exceptions prudently. When exceptions are not used prudently, are not
well managed, result in improper reporting, or mask delinquencies and
losses, management will be criticized and corrective action will be
required.

[^1]: Relevant GAAP guidance is provided in Financial Accounting
    Standards Board Statement No. 5, *Accounting for Contingencies*,
    which provides the basic guidance on accounting for loss allowances
    for the collectibility of receivables. Additional GAAP guidance is
    within Chapter 7 of the American Institute of Certified Public
    Accountants' (AICPA) Audit and Accounting Guide *Banks and Savings
    Institutions.* Banking and thrift regulatory guidance is included in
    the Call Report and Thrift Financial Report instructions as well as
    in the July 6, 2001 Interagency Policy Statement on Allowance for
    Loan and Lease Losses Methodologies and Documentation for Banks and
    Savings Institutions and the December 21, 1993 Interagency Policy
    Statement on the Allowance for Loan and Lease Losses.

[^2]: For purposes of this guidance, a workout is a former open-end
    credit card account upon which credit availability is closed, and
    the balance owed is placed on a fixed (dollar or percentage)
    repayment schedule in accordance with modified, concessionary terms
    and conditions. Generally, the repayment terms require
    amortization/liquidation of the balance owed over a defined payment
    period. Such arrangements are typically used when a customer is
    either unwilling or unable to repay the open-end credit card account
    in accordance with its original terms, but shows the willingness and
    ability to repay the loan in accordance with its modified terms and
    conditions.

[^3]: For regulatory reporting purposes, banks should report the
    creation of a specific allowance as a charge-off in Schedule RI-B of
    the Reports of Condition and Income (Call Report). Savings
    associations should report these specific allowances, along with
    other specific allowances, on Schedule VA in the Thrift Financial
    Report (TFR). Loans to which specific allowances apply should be
    reported net of specific allowances in the Call Report and TFR.

[^4]: Roll rate is the percentage of balances, or accounts, that move
    from one delinquency stage to the next delinquency stage.

[^5]: AICPA Statement of Position 01-6 *Accounting by Certain Entities
    (Including Entities with Trade Receivables) That Lend to or Finance
    the Activities of Others* provides guidance on accounting for
    delinquency fees.

[^6]: AICPA Statement of Position 01-6 provides recognition guidance for
    recoveries of previously charged-off loans.