As credit card issuers join in the banking industry's increased emphasis on fee income, consumers who pay their bills late or make purchases beyond their credit limits are discovering that such behavior can be costly.
To some observers, it seems eminently fair to tax such profligate behavior. "If you don't violate the contract you don't get stuck with these $10 or $15 bills," said Donald Auriemma, a card industry consultant based in Westbury, N.Y.
"Collection is a very expensive part of the business, and these fees have a sort of disciplinary effect on the cardholder," he said.
But a recent rise in such "nuisance" penalties may have more to do with the fact that traditional sources of income -- both interest rates and annual fees -- are eroding.
Trying to Compensate
"Basically, a lot of bankers increased their late charges when they reduced their pricing," said Brian J. O'Hare, president of Norwest Card Services, a Norwest Corp. unit in West Des Moines, Iowa.
According to the American Bankers Association's 1993 Bank Card Industry Report, 57% of banks with at least $750 million in card loans reduced their interest rates for new accounts and 71.4% reduced rates on existing accounts in 1992.
But it may be futile to expect fee income, no matter how important it becomes, to restore the income lost from the disappearing annual fee, lower interest rates, and anticipated increases in costs of funds.
Banks are still earning 68% to 77% -- depending on card program size -- of credit card revenue from interest rates, according to the ABA survey.
The average, unweighted interest rate fell this month to 15.98%, according to Robert B. McKinley, president of RAM Research Corp., Frederick, Md. The average rate -- 18.53% two years ago -- had never before been below 16%. And it continues to fall.
Also, at least half of cardholders are not paying the annual fees that became a key to profitability beginning in the early 1980s.
As a result, late fees went up to an average of $12 in 1992 from $10 a year earlier, said Credit Card News, an industry newsletter based in Chicago.
Pricing Strategies
Some issuers, however, have developed innovative pricing strategies that go beyond increasing the late fees and over-limit charges that came on the scene about a decade ago.
They run the risk of riling consumer advocates, who have become vigilant about all aspects of card pricing.
When First Deposit Corp. of San Francisco introduced a Visa gold product last year that included the equivalent of a commitment fee on business lines of credit, it thought it was blazing a new, customer-friendly pricing trail.
The customer determines how much credit to draw down, and pays 33 cents per $100 of the line of credit, which can be up to $10,000. There is no conventional annual fee.
Response from desirable customers -- heavy users of revolving credit -- was favorable, according to Shailesh Mehta, president of the credit card bank, which is owned by Capital Holding Corp., a Louisville-based insurance company.
What's more, the "customized credit" card charges 13.8% on purchases, pays a 1% rebate, and offers free "credit protection," which waives finance charges in the event of unemployment or disability.
The cardholder can decline the rebate and credit protection, and reduce the credit line fee to 12 cents per $100.
The minimum credit line is $300, the maximum $10,000, and the customer has the option of raising or lowering the line by multiples of $100 twice a year.
But First Deposit was attacked by consumer groups and the press, which saw the charge for unused credit as deceptive fine print, and alien to traditional pricing principles.
Inspired by Corporate Model
Mr. Mehta said his inspiration for the product came from the corporate model of lending, in which credit line fees are customary and chargeoff rates are much lower than those on credit cards.
"When a customer's financial situation deteriorates there is a stronger possibility that he will borrow against a larger line of credit than he is capable of repaying," said Mr. Mehta.
"So we are simply trying to get rid of irresponsible borrowing by giving the consumer the power to determine how much credit he actually needs."
Bankers generally do not expect First Deposit's pricing strategy will start a trend, even though there is a common perception that fees are not important to consumers.
|Insensitivity to Penalties'
"There seems to be an insensitivity to penalties," said Shelly Porges, chief executive officer of Porges Hudson, a consulting firm in San Francisco.
Charges associated with credit cards, excluding the annual fee, represent a small portion of total income.
According to the American Bankers Association's annual card survey, "nuisance" fees contributed 11 % to 1992 revenues, compared with 6% the previous year. While there was a 45% year-to-year increase in these fees, there was also a decline in revenues from annual fees and interest rates.
By raising the ancillary fees, issuers are attempting to compensate for shortfalls in their main sources of income. Also, the banks' cushion from record-low costs of funds is sure to disappear, and fee increases are one way to prepare for that inevitability.
|Better Deal for the Revolver'
Convenience usage -- by customers who do not revolve their monthly card balances -- is another spur to new pricing strategies.
"We have chosen to make our card a better deal for the revolver and a poorer deal for the convenience user," said Mr. O'hare of Norwest. "About 80% of our attrition is from people who are leaving because of the annual fee."
Norwest's overall strategy is to weed out unprofitable customers, by holding steadfastly to an annual fee. Even Norwest's introductory card offer, a 9.9% interest rate, comes with a $20 annual fee.
The interest rate on the bank's classic card is based on the prime rate plus nine points, in addition to a $20 annual fee. The gold card comes with a $40 fee and an interest rate equal to the prime plus 7.4.
It is estimated that a pure convenience user would have to generate at least $5,000 a year in transactions to yield a profit.
"Successful issuers are focusing on the revolving customer, because they realize that it simply doesn't make sense to accommodate the convenience user," said Ms. Porges.
|A lot of Resistance'
However, industry experts are also predicting that consumers who carry balances and enjoy the benefits of variable rates won't tolerate a return to high annual percentage rates.
"There will be a lot of resistance to rising rates," said Mr. McKinley of RAM Research. "Banks may find themselves adjusting their formulas."
Account attrition will be significant when rates rise, warned Joel Friedman, a partner in Andersen Consulting, San Francisco. He contended that consumers will move to products at lower fixed rates.
Another trend on a smaller scale is the elimination of grace periods -- the time before interest accrues on purchases. The Bank of New York, which has at least 2.5 million accounts without grace periods, helped to pioneer this practice. Less than 10% of issuers have followed suit by completely eliminating grace periods, a practice that would squeeze more profit from convenience users.
Other issuers are trying to chip away at the grace period by lowering it from 25 to 20 days, or by charging interest from the date of purchase rather than when the transaction is posted on the consumer's account.
"Eventually we will see [the grace period] disappear," said Mr. McKinley.
He pointed out that it has, in fact, disappeared for all but true convenience users. Cardholders may not understand that whenever they carry over a revolving balance, there is no grace period on new purchases.
