NEW YORK ( TheStreet) -- JPMorgan Chase's ( JPM) credit card arm is currently the lone loss maker from among the parent company's six business lines, but the firm is actively working to retool operations for when the business environment improves. It's no secret that credit cards are treacherous territory for issuers these days with unemployment, a barometer that's historically directly correlated with charge-offs, hovering around 10%. On top of that, new consumer protection laws set to kick in early in 2010 are expected to take a bite out of revenue, while increasing usage of debit cards is already cutting into transaction volumes.
These shifts in industry conditions come against a backdrop of overburdened balance sheets. Most card issuers took on too much risk earlier in the decade, and are now scrambling to clear the record amount of loans that are coming up uncollectible. At the same time, they are also trying to figure out new ways to squeeze profits from their card businesses, including raising interest rates, slapping consumers (even good credit ones) with annual fees, cutting credit lines and simply saying no to new borrowers, particularly before the regulations from the CARD Act become effective in February. JPMorgan, while facing the same challenges and admittedly opting to raise rates and cut the lines of some borrowers, is adopting a strategy of developing tailored products for creditworthy customer segments that it hopes will pay dividends
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"When you get right down to the heart of it, credit cards just make consumers and businesses lives easier," says Gordon Smith, CEO of Chase Card Services, in an interview this week with TheStreet.com. "That's why we think if we build the right products and services this is a terrific space to be in. ... Consumers and businesses are so busy today. The successful businesses take that complexity away." Besides JPMorgan, Bank of America ( BAC), Citigroup ( C), Wells Fargo ( WFC), American Express ( AXP) are also looking for ways to position their card businesses for the changing business environment. But JPMorgan is taking a different tact than just fees and higher interest rates, choosing instead to put the bulk of its efforts behind new product offerings that it hopes will result in the card business being in prime position to benefit when the fallout from the financial crisis has finally subsided. The company is targeting five distinct customer segments for card usage -- high-net-worth consumers, mass affluent consumers, small business owners, co-branded cards and retail partner/private label credit cards. As part of the effort, JPMorgan is looking to leverage its existing relationships with Disney ( DIS), Continental ( CAL), United ( UAUA), Southwest ( LUV) and Marriott ( MAR), among others, for co-branded cards, as well as its deals with retail partners such as Starbucks ( SBUX), Pier 1 Imports ( PIR) and Toys R' Us ( TOY). An early example of the strategic direction was the launch of the company's Chase Sapphire card series in August, whose ubiquitous advertising campaign featured the unmistakable voice of Frank Sinatra singing the standard "The Way You Look Tonight" in the background. The card targets the top 15% of U.S. households, who are large users of credit cards that expect "premium rewards, outstanding value and exceptional service," the firm says.
Chase Sapphire and its sister card Chase Sapphire Preferred offer affluent consumers premium travel services, and a wide variety of accessible rewards through the company's Ultimate Reward program and round-the-clock customer service representatives. JPMorgan didn't disclose how much these customers typically spend on the cards, but said in a press release that those who spend $50,000 a year on the Chase Sapphire Preferred card will get 10,000 reward bonus points, so they're aiming high. A JPMorgan spokesman said the company views the affluent market as having an annual household income of $125,000 or more, and that generally, these consumers represent about 45% of all credit-card spending. In September, the company launched its Ink product series, targeted to small business owners, who still primarily use cash and checks to pay for business expenses. Instead, JPMorgan wants this segment to put those expenses on a card. The cards offer business owners spending rewards, online expense management tools, the option for additional cards for employees, and customizable payment terms, as well as other features. One of the four Ink card options is for a pay-in-full charge card. Chase has also created a financial management tool called Blueprint to help credit card customers manage their finances and payments more accurately. It is available for both the Sapphire and Ink card series as well as the Chase Freedom and Slate series of cards. "The way we're going to make money is to become the primary vehicle to meet a customer's spending and borrowing needs," Chase Card CEO Smith says. "It's a business of very small margins. You have to run volume through the system. When a customer uses your card as their primary card for spending, there are good economics in it for us and a great value proposition for the customer."
Chase began its card transition in the beginning of 2008 -- when the financial crisis was still in its early stages and card losses were yet to be realized by most financial companies. Some seven months earlier it had hired Smith to head up the unit from AmEx, where he spent 25 years. And while the company admits that the environment is very different from when it first started the card business transition, it still expects to reap benefits. Management wants consumers to feel as if the Chase experience, from retail banking to debit cards to credit cards is seamless, Smith says. The Chase Card unit also has another arrow in its quiver these days -- Chase Paymentech, its merchant processing subsidiary, says Brian Riley, research director of bank cards at TowerGroup, a Needham, Mass.-based research and advisory services firm focused on the financial services industry. Last year, Chase Paymentech, which is headquartered in Dallas, dissolved its joint venture with First Data following that company's buyout by private equity firm Kohlberg Kravis & Roberts. "
The move gave them a really solid merchant processing business," Riley says. "Some banks like Capital One and Citigroup focus on consumer cardholders and miss opportunities on the merchant side. And many of the controls you have in place with cards can be carried over to merchant side. By taking it in-house it gave some additional ballast to their card business." "The company is still very interested in the card business and in fact is going to be increasing their marketing budget in that space in 2010," says Eric Schopf of Hardesty Capital Management, which owns JPMorgan shares. "I like what they're doing. It's in these sorts of environments that if you're aggressive and creative you can beat their competitors."
Still, JPMorgan admits that it won't begin to see the fruits of these efforts for at least two years. The Chase Card unit posted a loss of $700 million in the three months ended Sept. 30 and $1.9 billion for the first three quarters of fiscal 2009. CEO Jamie Dimon warned earlier this year that the business would not make a profit in 2009 and losses for the first half of 2010 are likely to come in "north of $1 billion." Loan losses remain at record levels, and the unit's legacy credit card portfolio had a managed net charge-off rate of 9.41% in the September quarter. Losses in the credit card portfolio of Washington Mutual, which JPMorgan bought in September 2008, have been far worse. The company says that charge-offs in the WaMu portfolio, primarily consisting of subprime accounts where the standards for receiving lines of credit were too lax, could rise to 24% by mid-2010. The company is currently working to wind down that portfolio, and Chase Card CEO Smith says they won't be extending further credit to the majority of those borrowers. The industry is going to be a "slightly smaller business because people are going to cut back credit in subprime and places that can't manage the risk properly.
W e think it will be a great business coming out of that, but you really won't see the results of that until 2011 and 2012," Dimon said during the October conference call for the company's third-quarter results.
Dimon added that card issuers must do a "better job underwriting upfront and if you want to maintain your clients a better job ... marketing the things such as rewards and services and things like that to grow the business." P/>Chase Card CEO Smith echoed that message. "We really are going through pain right now," he says. "It's the worst macro-environment the card industry at scale has ever seen. And we know we just got to work through it, so that's what we're doing ...
investing heavily through this cycle so that as we come out the other side we'll feel we'll have positioned the business with some really good products for our customers." --Written by Laurie Kulikowski in New York.