A big lender's credit card trap

By BusinessWeek

When Brad Kehn received his first credit card from Capital One Financial in 2004, it took him only three months to exceed its $300 credit limit and get socked with a $35 over-limit fee. But what surprised the Plankinton, S.D., resident more was that Cap One then offered him another card, even though he was over the limit -- and then another and another.

By early 2006, he and his wife had six Cap One Visa cards and MasterCards. They were in over their heads.

The Kehns were late and over the limit on all six cards, despite occasionally borrowing from one to pay the other. Every month they chalked up $70 in late and over-limit fees on each card, for a total of $420, in addition to paying high interest rates as a penalty.

The couple fell further behind as their Cap One balances soared. Even so, they still received mail offers for more Cap One cards. "I didn't open them," says Kehn, 33, who manages a truck stop and runs a carpet-cleaning business on the side. "I owe these people that much damn money and they are willing to give me another credit card? This is nuts." The Kehns sought relief at a credit counseling agency last May.

Credit card experts and counselors who help overextended debtors contend that Cap One is simply aiming to maximize fee income from debtors who may be less sophisticated and who may not have many options because of their credit history.

By offering several cards with low limits, instead of one with a larger limit, the odds increase that cardholders will exceed their limits, garnering over-limit fees. Juggling several cards also increases the chance consumers will be late on a payment, incurring an additional fee. And if cardholders fall behind, they pile up over-limit and late fees on several cards instead of just one.

Practice not well-known

"How many more ways can I fool you? That is all this is about," says Elizabeth Warren, a Harvard Law School professor and author of "Bankruptcy and Article 9."

Consumers may not be the only ones who are unaware of Cap One's ways. Its practice of issuing multiple cards to some borrowers with low credit ratings doesn't appear well-known in the investment community. And just how much Cap One relies on fee income, versus interest, is a mystery. Like most lenders, it doesn't disclose that.

All credit card companies have become more reliant on fee income in recent years, but in a report issued in 2002, William Ryan, an investment analyst at investor-research firm Portales Partners, warned that Cap One's earnings could be "devastated" if regulators cracked down on multiple cards or fees.

That hasn't happened. For now, Cap One's approach looks pretty savvy, however onerous it may be for some customers. Ronald Mann, a card-industry expert, says that by generating so much revenue from late and over-limit fees, as well as interest, Cap One likely more than offsets for the risk of cardholders filing for bankruptcy. "The premise is to make money even if (Cap One) never gets fully repaid," says Mann, a law professor at the University of Texas in Austin. (Mann has been retained by a party suing Cap One in a business dispute.)

In a written response to questions, Cap One acknowledges that it offers multiple cards. "Our goal is to offer products that meet our customers' needs and appropriately reflect their ability to pay," it says. The company also stated: "Within our current U.S. portfolio, the vast majority of Capital One customers have only one Capital One credit card with a very small percentage choosing to have three or more cards."

Spokeswoman Tatiana Stead declined to offer precise numbers or to say whether households with three or more cards were concentrated among "subprime" borrowers, people with low incomes and/or bad credit histories.

The nation's fifth-largest credit card issuer, with $49 billion in U.S. credit card receivables as of the end of June, Cap One is a major lender to the subprime borrowers. According to Cap One's regulatory filings, 30% of its credit card loans are subprime.

Representatives of 32 credit counseling agencies contacted by BusinessWeek say that Cap One has long stood out for the number of cards it's willing to give to subprime borrowers. "In the higher-risk market, no lender is more aggressive in offering multiple cards," says Kathryn Crumpton, manager of Consumer Credit Counseling Service of Greater Milwaukee. Other big card-industry players that do subprime lending include Bank of America, Chase and Citigroup. Representatives for Chase and Citigroup say they do not offer multiple cards to subprime customers; Bank of America did not respond to inquiries.

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