Biden's late-fee crackdown is a blow to department stores. Shoppers should beware of what comes next.

By Bill Peters

'Fees can be like whack-a-mole,' analyst says. 'One goes down, another comes up.'

Some of the biggest clothing and department-store chains rely on their own private-label credit cards to cushion their bottom lines. Those cards, often laden with incentives, keep shoppers coming back, and give retailers reams of consumer data that feed ever more persistent marketing efforts.

But after the government this month put limits on how much retailers and banks can collect on late credit-card payments, experts say that while retail customers might get a break on late-payment penalties, store cards might get more expensive to use in other ways, as retailers and the banks that issue their credit cards push back to protect profit growth.

The Consumer Financial Protection Bureau this month finalized a rule that caps credit-card late fees for the largest card-issuing banks, lowering them, generally, to $8 from around $32. Assuming the rule, set to take hold in the weeks ahead, survives legal challenges from business advocates, the agency said families could save billions in late fees.

But shoppers might also experience more aggressive card promotions at the checkout counter. And the banks that work with those retailers could raise interest rates and tack on fees to those cards - at a time when some research shows that annual percentage rates already sit at record highs.

BofA analyst Lorraine Hutchinson, who follows retailers like Kohl's Corp. and Nordstrom Inc., said store credit cards were an important income stream for retailers, and that late fees were part of the reason why they were lucrative for retail chains and their credit-card partners.

"The overall broader impact is a reduction in income that they earn from their private-label credit card," she said of the CFPB's new rule. Retailers, she said, "will all work really hard to offset it."

The CFPB made the rule change as Americans face higher interest rates, higher costs for basics like groceries and continue to have difficulty paying bills on time. The agency also argued that big card issuers profit from late fees well in excess of their costs. Business groups and some analysts, meanwhile, said the move risked harming the same customers the government is trying to protect.

Retailer 'mitigation' efforts

Kohl's (KSS), during its earnings call this month, said it would expand the reach of its co-branded credit card, launched with Capital One, as the new rule takes hold in the weeks ahead.

"That credit customer's incredibly important to us, not just from the credit revenue side, but they shop us the most," Jill Timm, Kohl's chief financial officer, said during the call. "They give us the most share of their wallet. And we have been testing the co-brand card to really be an extension of that loyalty."

She continued: "And so as we assume the CFPB legislation goes into the back half of the year in conjunction with that, we're also rolling out the co-brand card to another 5 million customers, which helps us then offset some of those headwinds."

In February, Macy's Inc. (M) said during its earnings call that the late-fee change wasn't included in its outlook for this year. The company said it was working with Citi, which issues Macy's credit cards, on "mitigation factors." But it also said it would try to get shoppers to swipe the chain's own card more frequently.

"I think the more important conversation is how do we actually increase usage of our credit card?" Chief Financial Officer Adrian Mitchell said on the call. "And there's a lot of work that's happening around our loyalty program, around the use of our credit card to drive engagement with our customer, and just thinking about that program more broadly."

Nordstrom (JWN), which offers a credit card issued by TD Bank USA, said during its earnings call this month it hadn't disclosed how much of its income hinges on late fees. But it said that amount was "less than our competitors given the quality of our credit portfolio."

Gap Inc. this month said it had "other levers within our credit card program" to counterbalance the effect of the CFPB's ruling.

Hutchinson said that credit income, as a percentage of profit before interest and taxes, was 66% for Kohl's and 47% for Nordstrom.

Macy's, when reached, declined to offer any more detail beyond what management said during its earnings call. Kohl's, Gap (GPS) and Nordstrom did not respond to requests for comment.

Record APRs

An analysis by Federal Reserve economists in 2022 found that "fees - in particular late fees - comprise approximately 15 percent of credit card profitability." Bankrate, in October, said the average APR for retail credit cards stood at 28.93%, a record high, up from 26.72% in 2022, as the Fed hiked interest rates during time in between. Rates for cards from Walgreens, Ross Stores Inc. (ROST), Victoria's Secret & Co. (VSCO), and TJX Cos.' (TJX) T.J. Maxx were higher than 32%, Bankrate found.

Retailers, in general, make money off their private-label cards in a few different ways, Hutchinson said.

There's some money they get when a customer opens a card account at the register, and the chains earn a small percentage from transactions on that card, she said. They also get money from late fees and interest income. The exact share they get depends on the agreements struck with the card companies. Discounts and other incentives offered through the card are normally funded by the retailer, she said.

The CFPB proposed the late-fee limit last year. At the time, the agency said the rule would realign the income that credit-card companies take in from late fees with the costs associated with collecting them. Preliminary estimates by the agency at that time also found that the money the biggest card issuers got from late fees was around five times larger than those collection costs.

The agency, in a statement this month finalizing the rule, said the rule would save consumers more than $10 billion in late fees a year once it went into effect, or an average savings of $220 a year for the 45 million-plus people who get hit with late fees.

And it said it believed a late fee of $8 would be enough to cover the collection costs. It also said that big card issuers could charge fees above that limit if they can show it was needed to cover actual collection expenses.

"For over a decade, credit-card giants have been exploiting a loophole to harvest billions of dollars in junk fees from American consumers," CFPB Director Rohit Chopra said in a statement this month. "Today's rule ends the era of big credit card companies hiding behind the excuse of inflation when they hike fees on borrowers and boost their own bottom lines."

The whack-a-mole game of regulations and fees

But the financial industry, under investor pressure, will likely act quickly to cover any profit shortfalls.

BofA consumer finance analyst Mihir Bhatia, in a recent note, said credit-card issuers would likely tighten underwriting standards in response to the rule. In a filing this month, Synchrony Financial (SYF), which offers credit cards for retail chains like Walgreens and Lowe's Cos., said that it could increase annual percentage rates and implement other fees.

Lowes (LOW) also said that as of March 7 - days after the CFPB's announcement - purchase APRs for new accounts on its new MyLowe's Rewards rewards card would be 31.99%, higher than an earlier version of the card. Lowe's and Synchrony did not respond to requests for more information.

Morgan Stanley analysts, in a note this month, said that Synchrony gets around 16% of revenues from late fees. Legal challenges to the CFPB's rule, the analysts said, were likely.

"The rule seems likely to face almost immediate legal headwinds, based on the pushback and letters from various trade groups (including the Bank Policy Institute, American Bankers Association, U.S. Chamber of Commerce) that have issued comment letters over the past year, offering strong pushback against the rule," the Morgan Stanley analysts said.

This month, the U.S. Chamber of Commerce, a large business advocacy group, filed a lawsuit against the CFPB. The group called the agency's rule a departure from years of regulations and accused the agency of overstepping its legal authority and basing its analysis on "secret data collected from only the largest banks for a different purpose and by a different agency."

"By significantly limiting late fees, the CFPB is not only discouraging responsible credit card use but also imposing higher costs on consumers and limiting choices in credit card options and benefits," the group said.

The Bank Policy Institute, an advocacy group for the nation's biggest banks whose board includes many of their executives, said last year the rule would lead to an increase in late payments and delinquencies, hurting consumer credit scores in the process.

"Credit card late fees are transparent, highly regulated and apply equally to all customers that fail to pay their minimum amount due on time, regardless of income level or credit score," Paige Pidano Paridon, a senior vice president at the group, said in a statement at that time.

Some consumer groups praised the CFPB's rule this month.

Chi Chi Wu, senior attorney at the National Consumer Law Center, said the rule "will help the balance sheets of millions of households stretched thin by record-high housing costs and other expenses."

The Consumer Federation of America also pointed to a Consumer Reports survey from last year that found a majority of participants supported lowering credit-card late fees. The group also cited CFPB research finding that credit availability still increased even as the agency tried to clamp down on fees.

Still, other analysts saw risks. Ted Rossman, a senior industry analyst at Bankrate, told MarketWatch via email that the late-fee cap could have unintended consequences.

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03-27-24 1140ET

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