By Mitchell Pacelle
Wall Street Journal

When Jennifer Reid opened her credit card statement in April, she discovered how expensive it was to make full use of her credit.

The 42-year-old X-ray technologist had run through $10,000 of her $12,000 credit line on an MBNA Corp. card. In April, her annual interest rate abruptly jumped to 24.98 percent, up from 19.98 percent the previous month and far above the initial single-digit rate.

“I don’t understand,” she recalls telling an MBNA customer-service representative on the phone, complaining that she hadn’t been late with a single payment. The representative agreed but pointed out that she had run up more than $5,000 of debt on two other cards. Also, she was making only slightly more than the minimum suggested monthly payments on her MBNA card. He said the company now saw her as a credit risk and feared it would take her forever to pay off her debts.

“Isn’t that what you want consumers to do?” she snapped back.

That’s a question more financially strapped bank customers are asking these days. For consumers who pay off their credit card balances each month, shop aggressively for interest rates as low as zero percent and take advantage of generous credit-card rewards programs, consumer credit has never been cheaper. But for others, such as Reid, who went into debt so she could move to a better job in Florida from South Carolina, the trend is in the other direction.

Card users, consumer advocates and some industry experts complain that banks are attempting to squeeze more and more revenue from consumers struggling to make ends meet. Instead of cutting these people off as bad credit risks, banks are letting them spend – and then hitting them with larger and larger penalties for running up their credit, going over their credit limits, paying late and getting cash advances from their credit cards. The fees are also piling up for bounced checks and overdrawn accounts.

“People think they are being swindled,” said industry consultant Duncan MacDonald, formerly a lawyer for the credit-card division of Citigroup Inc.

Penalty fees aren’t new, but they are becoming more important to the industry’s bottom line and are being borne by the people who can least afford to pay them, he said.

CardWeb.com, a consulting group that tracks the card industry, says credit card fees, including those from retailers, rose to 33.4 percent of total credit-card revenue in 2003. That was up from 27.9 percent in 2000 and just 16.1 percent in 1996. The average monthly late fee hit $32.01 in May, up from $30.29 a year earlier and $13.30 in May 1996, the company said. In 2003, the credit card industry reaped $11.7 billion from penalty fees, up 9 percent from $10.7 billion a year earlier, according to Robert Hammer, an industry consultant.

“As competitive pressure builds on the front-end pricing, it has pushed a lot of the profit streams to the back end of the card – to these fees,” said Robert McKinley, chief executive of CardWeb.com.

Over the past two years, he said, “it’s become much more aggressive.” At industry conferences, he noted, talk often turns to “what the market will bear.”

Banks say that penalties and fees are a necessary component of new models for pricing financial services. Gone are the days when banks collected hefty annual fees on all credit cards and charged fat interest rates to all customers.

Now, the banks say, they must rely on risk-based pricing models under which customers with the shakiest finances pay higher rates and more fees.

“We look at teaser rates as an area that we have to be competitive in,” said Richard Srednicki, a top credit-card executive at J.P. Morgan Chase & Co., during a conference call with investors last fall. He said the bank tries to “mix and match how we compete” on interest rates and fees “in order to make the kinds of returns that we’re looking for.”

An MBNA spokesman declined to comment on Reid’s experience but noted that one of the most important considerations in setting a credit card’s interest rate is “how a customer manages his account.” If a customer’s financial circumstances change for the worse, he said, the bank has to raise the rate “as a way of balancing that greater risk.”

Such variable pricing has been embraced in recent years by airlines, mortgage lenders and others. What raises the hackles of bank customers, however, is that many don’t discover the rate changes and penalty fees until they have already been hit with them. Those who complain are directed to disclosure statements that most consumers never read.

These disclosures, MacDonald said, have ballooned from little more than a page 20 years ago to 30 pages or more of small print today.

Federal Comptroller of the Currency John D. Hawke Jr., one of the nation’s top bank regulators, warned bankers at a conference last fall that “no retail banking activity generates more consumer complaints” than credit card practices, “and where there are persistent and serious complaints, there is a fertile seedbed for legislation.”

Hawke raised the case in which a customer presents a credit card at the cash register and the bank approves the transaction even though it knows that the purchase will push the customer over his credit limit.

“If, as a practical matter, the line has been increased, is it unfair or deceptive for the creditor to continue to impose an overline ‘penalty’?” he asked.

Until the early 1990s, most banks offered one main credit card product. It typically carried an annual interest rate of about 18 percent and an annual fee of $25. Cardholders who paid late or strayed over their credit limit were charged modest fees. Profits from good customers covered losses from those who defaulted.

Then card issuers, in an effort to grab market share, began scrapping annual fees and vying to offer the lowest annual interest rates. They junked simple pricing models in favor of complex ones they say were tailored to cardholders’ risk and behavior. Eager to sustain growth in a market approaching saturation, they began offering more cards to consumers with spotty credit.

By the late 1990s, banks were attracting consumers with low introductory rates, then subjecting some of them to myriad “risk-related fees,” such as late fees and over-limit fees. A 2001 survey by the Federal Reserve showed that 30 percent of general-purpose credit-card holders had paid a late fee in the previous year.

Like Reid, more customers are seeing red when they discover the penalties on bank statements. Credit card late-payment charges have risen to as high as $39 for some customers of Bank of America Corp., MBNA, and Providian Financial Corp., and fewer banks grant grace periods.

In a survey of 140 credit cards this year, the advocacy group Consumer Action said 85 percent of the banks make it a practice to raise interest rates for customers who pay late – often after a single late payment. Nearly half raise rates if they find out that a customer is in arrears with another creditor.

Because the banks disclose the fees in the fine print of their mailings, they have had little to fear from regulators and the courts. Consumer lawyers have lost a string of lawsuits challenging such practices. A little-noticed April ruling by the U.S. Supreme Court said credit-card companies don’t have to include various penalty fees when they calculate the “finance charge” listed on a customer’s monthly statement.

Banks are charging as much as $32 per transaction when customers write a check or make a debit-card purchase without enough money in their accounts to cover the payment. Five years ago, $20 was more typical.

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