Finance August 13, 2009, 5:00PM EST

A Different Kind of Credit-Card Company

With a new federal credit-card law coming, PartnersFirst's model of no fees, steady rates, and reduced risk may point toward the industry's future

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The Service Employees International Union has frequently blasted credit-card issuers over the years for abusive lending practices. When the SEIU started searching for a firm to create a branded card for its 2 million members, union leaders demanded fewer fees and less onerous penalties. "We wanted a card that was more consumer-friendly," says Jeremy Smith, a deputy director at the SEIU. "[Most] card companies wouldn't consider our proposal."

Hal Erskine, the founder and president of PartnersFirst, did. In April his Wilmington (Del.) financial firm introduced an SEIU credit card that met the union's tough standards. The card, which has an average interest rate of 16%, doesn't levy annual fees or impose late-payment charges. And PartnersFirst won't hike rates or change terms without the SEIU's permission.

PartnersFirst is a different kind of credit-card company. Started in 2007 with funding from Western Alliance Bancorp (WAL), the fledgling firm has three key tenets: keep rates steady, eliminate fees, and rigorously evaluate the risk of potential customers. PartnersFirst mainly makes money from the interest it charges borrowers, whereas most credit-card companies also rake in huge fees. "I realized that there was an opportunity to give cardholders a square deal and still make a profit," says Erskine, 49, who says he was fired in 2007 from MBNA in the wake of its merger with Bank of America (BAC).

Before the financial crisis hit, a tiny upstart like PartnersFirst wouldn't have been much of a competitive threat. Long-entrenched behemoths Bank of America, Citigroup (C), and JPMorgan Chase (JPM) dominated the industry, with a combined 60% market share. Capital One Financial (COF) now spends $1.2 billion a year on marketing, compared with around $5 million for PartnersFirst. And PartnersFirst hasn't turned a profit in its first two years.

But the landscape is changing. The stalwarts are struggling as defaults rise amid the recession. Then there's the Credit Card Accountability, Responsibility & Disclosure Act of 2009, new federal rules that address everything from billing practices to fee structures—and threaten the industry's earnings. In light of the new law, which takes effect next year, "credit-card companies have to fundamentally change their business model," says Gene J. Truono Jr., a managing director at BDO Consulting and former chief compliance officer at American Express (AXP). The upshot: Some credit-card issuers may have to act more like PartnersFirst.

RAW DEALS?

Erskine used to be part of the credit-card Establishment. After picking up his MBA from Wharton School in 1992, he joined MBNA as vice-president of strategic planning. There he pioneered affinity relationships, the deals in which credit-card companies fork over millions of dollars to universities, nonprofits, sports teams, and other institutions for access to their members' valuable data. The cards often are emblazoned with the mascot or logo of the organization.

Credit-card companies have made billions on affinity cards over the years—but regulators and lawmakers worry that consumers get raw deals. Critics say colleges put their financial interests ahead of those of their students, encouraging them to rack up high-cost debt. "Affinity cards started simply as a product that alumni associations could offer members, but alumni boards realized they could bargain for more cash up front," says Lewis Mandell, a professor at the University of Washington's Foster School of Business.