New billing policies help put squeeze on credit companies
By Lisa Kassenaar
Bloomberg News Service
NEW YORK — William Janklow's law office in Sioux Falls, S.D., is crowded with mementos from his 16 years as a Republican governor. On a low, wooden bookcase, near bottles of hot sauce custom labeled for his annual Buffalo Roundup, he keeps a 4-foot length of red ribbon festooned with Citibank credit cards.
Janklow is the politician who, in 1981, brought Citibank to South Dakota. When he cut that ribbon to welcome the New York- based bank, he blew the lid off the U.S. credit card business, Bloomberg Markets reports in its June issue.
The law inviting Citibank to South Dakota threw out limits on how much interest the state's banks could charge borrowers. In a secret meeting at the governor's residence with Walter Wriston, chief executive officer of Citicorp, Janklow agreed to drive through the legislation in a swap for 400 jobs.
"That was the deal," Janklow said. "You have no idea, in a state of 750,000, how many 400 jobs is, all in one place."
The business Janklow and Wriston set in motion with a handshake that evening transformed U.S. consumer lending. A year after South Dakota lifted its rate caps, usury rules were relaxed in Delaware, where the credit card businesses of JPMorgan Chase & Co. and Bank of America Corp. are based. Federal law allows banks to lend according to the rules of the states in which they are based.
Once interest rates were allowed to rise as high as banks could push them, credit cards became a ticket to enormous profit. In the decade ended on Dec. 31, 2007, credit card issuers together earned more than $50 billion. At JPMorgan Chase, cards accounted for 20 percent of both revenue and profits in 2007.
"The credit card business has been a critical driver for these companies; it was the single most profitable product in the lending arena next to mortgages," said Richard Bove, an analyst at Rochdale Securities in Lutz, Fla.
Then the harshest economic decline since the 1930s crushed the job market, and a record number of card holders stopped paying their bills. The three biggest card-issuing banks lost at least $7.7 billion on cards in 2009. Bank of America, after earning $4.3 billion on cards in 2007 — a third of its total profit — swung to a $5.5 billion loss in 2009. JPMorgan Chase lost $2.2 billion last year on cards and, in mid-April, reported a $303 million loss for the first quarter.
"We have a business that is hemorrhaging money," sid Paul Galant, CEO of Citigroup Inc.'s card unit, where Citi-branded cards lost $75 million last year. The bank won't disclose how much it lost on cards it issued under the names of retail stores.
U.S. credit card issuers wrote off a record total of $89 billion in card debt in 2009 after losing $56 billion in 2008, according to R.K. Hammer Investment Bankers, a Thousand Oaks, California-based adviser to card issuers.
For Charlotte, N.C.-based Bank of America, the sea of red ink began to recede in the first quarter. It reported $952 million in profit from cards after releasing reserves set aside in 2009 to cover defaults.
As the economy revives, defaults will ease. Washington's assault on the industry may not. In February, the Credit Card Accountability, Responsibility and Disclosure Act wiped out many of the banks' most lucrative billing practices, including their ability to raise rates on existing debt at any time.
Now, the banks have to give cardholders 45 days' warning on any rate rise and can't apply a new rate on existing debt. JPMorgan Chairman and CEO Jamie Dimon said during an earnings conference call in April that the changes will cost his bank up to $750 million in 2010. Banks overall may lose $50 billion in revenue during the next five years, said Robert Hammer, CEO of R.K. Hammer Investment Bankers.
"The banks are feeling the squeeze," said Elizabeth Warren, the Harvard Law School professor who chairs the Congressional Oversight Panel of the government's Troubled Asset Relief Program.
"Everyone has more credit cards than they want," Warren said. "There is no more growth."
The lenders are busy reinventing the risk models they used to justify passing out plastic to almost anyone who would take it.
"We have shifted to more judgmental lending," said Susan Faulkner, who took over Bank of America's card operation in early March. That means judging borrowers on, for instance, the type of mortgage they hold.
The borrowers that card issuers want are richer and more-stable payers than the hordes they marketed to during the boom years. They're all chasing American Express, which has long catered to a wealthier group. The firm made $2.1 billion in 2009, and its stock was the top performer in the Dow Jones Industrial Average, returning 118 percent.
"The business has to be right-sized," Faulkner said. "There was too much credit extended; customers over- extended themselves in the use of that credit."
Janklow is sympathetic to the woes of the industry that helped make his career. Yet he understands the public anger at the high rates and fees.
"There is an old saying in capitalism: 'What you abuse, you lose,' " Janklow said.
The question now is whether the executives running the credit card industry have gotten the message.