Credit card issuers are relying more on cardholder fees, particularly late fees, as a revenue source to make up for the volatility in interest rate income. This trend, however, is whipping up the ire of consumer groups, and even some industry consultants worry about the adverse effect the charges eventually could have on cardholders.
Last year, issuers collected an estimated $16.4 billion in penalty fees, 70% of which were late fees, says Robert K. Hammer, president of R.K. Hammer Investment Bankers. This compares with $14.8 billion in fees collected in 2004 and $11. 7 billion in 2003, he says.
"Fee income is rising in terms of importance, and interest income is declining as a percent of total income," says Hammer, who began keeping statistics on fee income three years ago.
Fee income has grown in importance in a very short time, says William W. Shaw, president of First Citizens Bank N.A., the Visa and MasterCard-issuing arm of First Citizens BancShares, concurs. "Seven to eight years ago, 75% to 80% of the card industry's gross revenue came from interest income," Shaw says. "Today, interest income accounts for 60% of gross card-industry revenue, and income from fees accounts for 40%."
The card industry's growing reliance on fee income has not gone unnoticed by consumer groups, who contend issuers are harming their customers with rising fees. Some issuers, though, are responding to consumers' concerns through new products that waive late fees and through e-mail messages that alert cardholders when their bills are coming due.
Some 5.5% to 6% of cardholders are late with their card payments every month, according to Hammer.
The card industry's growing reliance on late fees has been sparked in part by the wild swings in interest rates set by the Federal Reserve, says Greg McBride, senior financial analyst at Bankrate.com, a Web aggregator of financial information. In mid-2000, the federal funds rate-the basis for the prime rate and the common benchmark credit card issuers use in setting their interest rates for unpaid balances-reached a five-year high of 6.5%. From June 2003 to June 2004, though, the rate plunged to a 45-year low of 1%, McBride says.
Since that time, though, the federal-funds rate has been on a constant rise. On Jan. 31, the Fed raised the rate to 4.5%, the 14th-consecutive quarter-point increase. Issuers responded by pushing the average credit card interest rate above the 13% mark, IndexCreditCards.com Credit Card Monitor data show. Major issuers, including Bank of America, Citibank, National City, U.S. Bancorp and Wells Fargo raised their rates another quarter of a point on their variable-rate cards.
McBride, though, does not believe the latest rate increase will reduce the card industry's appetite for late fees. "Fees are a counterbalance to the volatility of interest rates," McBride says. "The card industry has a flat yield curve that has squeezed margins, and that points to the importance of fee income."
A number of other factors also have caused issuers to rely more on fee income. Many homeowners, for example, used relatively low loan-interest rates over the past few years to refinance their mortgages or to take out home-equity loans. In doing so, many used a portion of the loan funds to pay off credit card debt, leaving issuers with fewer card receivables from which they could earn interest income, says Ken Posner, equity analyst and managing partner for Morgan Stanley.
From 1970 to 1974, credit card receivables had an average growth rate of 14% before falling to 9% from 1995 to 1999. Posner predicts receivables will grow 3% this year and 2% in 2007. Soon thereafter, he says, receivables could experience negative growth.
Another factor that has affected interest income is the increased competition between issuers over interest rates, says Paul Grill, a partner with First Annapolis Consulting LLC of Linthicum, Md. Issuers have accelerated the competition by offering rock-bottom rates because the U.S. card market is considered to be mature. Grill cites as an example 0% teaser rates that issuers offer to new cardholders for up to one year.
The growth in consumer use of debit cards, which do not generate interest income for financial institutions, also has hurt credit card issuers. "There has been a shift from cash and checks to credit cards," says Ron Mazursky, director of Edgar, Dunn & Co. "But with respect to cards, there has been a shift to debit cards from credit cards, and card issuers aren't making as much money from debit cards as they do with credit cards."
Revenue Needs
Because of the decline in interest income, issuers have looked for other revenue sources, says McBride of Bankrate.com. "There has been an increased reliance on fees, including punitive fees such as over-the-limit fees and late fees, so card issuers can diversify their revenue stream," he says.
Late fees, however, have received most of the attention among consumer groups, which perceive them to be high. And they are getting higher.
In 1994, late fees averaged $12.55. By 2000, the average reached $27.10. Last year the average was up to $34.42. Bankrate.com, which surveys the 50 largest credit card issuers weekly about their late fees, said in mid-January the highest late-payment fee was $49. Compass Bank of Birmingham, Ala., charged that amount for a delinquent payment on its platinum Visa card. Compass did not return calls seeking comment about its fee policies.
Most national issuers do not charge a flat late fee; they charge tiered fees based on a cardholder's outstanding balance, says Mazursky. Citi Cards, the credit card issuing arm of Citibank, for example, charges a $15 late fee for balances of less than $100, $29 for balances ranging from $100 to $1,000 and $39 for balances exceeding $1,000.
Discover Financial Services, issuer of the Discover card, also charges tiered late fees. Discover charges its customers $15 when balances are less than $100, $25 on balances of $100 to $1,000, and $39 when balances exceed $1,000.
Bank of America, the nation's largest card issuer in terms of receivables, also charges tiered late fees of $19 for balances of $250 or less and $39 for balances exceeding $250, a spokesperson tells Cards&Payments. BofA charges a late fee because there is increased risk of financial loss to the bank when a bill is past due, the spokesperson says.
Indeed, issuers' late-fee charges "have gone from a slap on the hand to a real hit," contends James Accomando, president of Accomando Consulting. "At one time, card issuers allowed cardholders to pay their bills 30, 60 and sometimes 90 days late before they would charge a late fee. And even then, the cardholder could call the issuer and have the charge reversed."
That often is no longer the case, says Hammer of R.K. Hammer. "Issuers are charging late fees much faster, and the fees are much higher," Hammer says.
Some issuers, though, have responded to cardholder concerns about late fees by issuing credit cards that do not charge them.
Citi Cards, for example, has acknowledged cardholders' wishes for a card that does not charge a late fee by introducing Simplicity. The issuer will not charge Simplicity cardholders late fees if they use the card at least once a month for purchases or cash advances.
American Express Co. also recently rolled out a credit card, called Clear, that similarly does not impose late-payment fees. In fact, AmEx does not charge any fees for the card, and it does not require cardholders to use the plastic a specific number of times each month to avoid paying late fees.
"We talk to consumers all of the time, and as a group they said they wanted a card that is simple and easy to use," says an AmEx spokesperson.
The Clear card comes with a 0% interest rate for the first six to 12 months, depending on AmEx's evaluation of the individual's card application. Thereafter, the annual interest rate applied to unpaid balances shoots up to 13.24%, 15.24% or 17.24%.
AmEx says it can offer Clear with no fees because its business model is different from that of other issuers. "We have a spend-based business model," the spokesperson says. "Our revenue is based on what cardholders charge on their cards, so we're not reliant on late fees like some other issuers."
Payment Notices
Other card issuers are using payment-due notices sent by e-mail to help consumers avoid being assessed late fees. Discover Financial Services, issuer of the Discover card, for example, urges its cardholders to sign up for its monthly e-mail alert system, which lets them know when their payments are coming due. A billboard ad promoting the service reads: "E-mail alerts remind you to pay your bill. So long late fees."
Ed Furman, Discover marketing director for e-commerce, says the issuer launched the e-mail reminder service in 1999 to help cardholders who, because of their busy schedules, may forget to pay their credit card bills on time. "No one likes late fees," Furman says. "The alert system helps the cardholder avoid them and better manage their accounts."
Other issuers, including MBNA Corp., offer similar e-mail alerts to help cardholders to avoid facing late fees.
Consumer-advocacy groups say it is not surprising that issuers would address their customers' late-fee concerns. "Late fees are a nightmare for consumers," says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group. "Regulators have allowed card issuers to impose late fees on cardholders often when the consumer really isn't late."
Mierzwinski cites as an example a payment, due on Sunday, that the mailman delivers on Monday. Even though Sunday is not a business day, the issuer charges the cardholder a late fee because it did not receive the bill on time, he says.
Moreover, Mierzwinski notes, when a cardholder makes a late payment, it could result in more than just a one-time payment. Issuers can raise the cardholder's interest rate and shorten the grace period because the cardholder violated terms of the cardholder agreement.
"It's like being hit with a baseball bat twice," Mierzwinski says. "First you are hit with a late fee, and then you are hit with higher interest rate. If you have a balance on the card, and you are paying interest rate of 20%, 30% or 40%, this does a lot more damage in the long run than a one-time late fee."
Under Citi's cardholder agreement, for example, cardholders who fail to make payments on time are in default. Citi's default interest rate on its Simplicity card is a variable rate of 30.99%, according to its cardholder agreement.
Citi only imposes the late payment after determining the cardholder's overall risk potential. "A particular late payment may not immediately trigger default pricing," a Citi spokesperson says.
Late fees are growing because issuers have reduced the period between when cardholders are billed and when the bills are due. Hammer of R.K. Hammer says over the years this period has dropped to 22 from 31 days.
Issuers also have quietly eliminated any leniency period when card payments can be submitted late without penalty, says Ken McEldowney, Consumer Action's executive director. McEldowney says the leniency period of three to 10 days after a card payment is due has disappeared. He also acknowledges that there is growing anecdotal evidence that issuers are mailing billing statements later and later.
Consumer Action's allegations have caught the attention of some lawmakers in Congress. Sen. Christopher Dodd (D-Conn.) has introduced the Credit Card Act of 2005. The bill, S499, which is still before the Senate Committee on Banking, Housing and Urban Affairs, would require issuers to use the payment envelope's postmark as the date when the issuer receives a cardholder's payment, not the day when the issuer credits the payment to a cardholder's account.
Mierzwinski believes S499 stands little chance of getting out of committee because of the credit card industry's influence over Congress.
The industry will continue to rely more on fee income, including late fees, as interest income remains volatile. And the strategy will continue to rile consumer groups and rattle some card industry consultants.
NEWS FLASH
Visa International is developing a payment card that generates and displays an eight-digit pass code that consumers would use when conducting online purchases or banking transactions. The randomly generated pass code would add a further layer of security to the password that many financial institutions and merchants already require for transactions, says Debbie Arnold, Visa vice president, product and market integration. The card is known internally as display card authentication, though it does not yet have a marketing name, says a Visa spokesperson. A cardholder would generate the code by pressing the Visa logo on the card's front. A digital box in the upper right corner would display the number. The pass code would be stored in the merchant's or financial institution's database tied to the consumer's card or password.
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Late Fees Take on A Bigger Issuer Role
March 01, 2006, 12:25 p.m. EST 10 Min Read
